Morgan Creek: Why 2014 Will be the Inverse of 2013VW Staff
Morgan Creek has $4.5 billion in AUM and is hosting a conference today in North Carolina with guest speakers including John Brubank of Passport Capital, Van Hoisington of HIMCO, David Hornick of August Capital, author Burton Malkiel and David Zervos of Jefferies. Reporters can follow on Twitter with the hashtag #ICIO2014.
The theme of last quarter’s letter, titled 10 Things I Hate About Spoos, revisited a construct we have discussed in prior letters (including Defense Wins Championships ) and we analyzed a series of ten charts (actually there was a bonus eleventh too) that showed that perhaps it was time to be a little more cautious in the U.S. equity markets after
such an incredible year in 2013 (to cap an incredible five year run off the bottom in 2009). To summarize, we wrote that “revisiting the reasons to be defensive in the equity markets again this year, it appears from the above charts that the strategies that produced such amazing results in 2013 may not produce a repeat performance in 2014.” It is from the second line of this quote that we draw our inspiration for the title of the letter this quarter as we will hypothesize why 2014 is likely to be the inverse of 2013, and we will also review some good evidence that the construct has already taken effect during the first four months. The Alligator is an animal that engenders some trepidation in most people and that fear is warranted based on the damage that a gator can do if you invade his habitat. To that point, there is a great line from an interview with Jack Ma, the founder of Alibaba Group, who talks about being a crocodile (yes, different than an alligator, but same idea) in the Yangtze River trying to fight the shark (eBay Inc (NASDAQ:EBAY)), “if we fight in the ocean, we lose, but if we fight in the river, we win.” The key is to avoid the Alligator’s habitat if you want to survive, so the message of this letter will be that we should avoid the traps of chasing the hot performing asset classes of 2013 and find new, less gator infested, waters to explore in 2014 and beyond.
The Chinese Zodiac (“Shengxiao” or “Birth Likeness”) is a cycle of 12 years that follows the lunar cycle in nature. Each year of the cycle is depicted by a different Animal (shown in image above) that is associated with the core characteristics of personality. The Animal represents how others perceive an individual or how that individual presents himself to the world. Additionally, there are five elements (fire, water, wood, earth and metal) linked to the Animals, also in a cyclical pattern, that create a 60 year overall cycle of different personality types. 2013 was the Year of the Water Snake, and Snake Years have historically been full of two opposing forces of conflict (1941 Pearl Harbor, 1989 Berlin Wall/Tiananmen Square, 2001 World Trade Towers) and technological innovation and progress (1953 Color TV, 1965 first desktop computer). Interestingly, related to markets, it is the only year of the twelve with a negative average return and some of the largest market drops have occurred in Snake years (1929, 1977). However, the Water element has a calming influence on the snake and there was a chance that conflicts and uncertainty (Fiscal Cliff, Egypt Uprising) would be quelled quickly and that the year would turn out to be rather prosperous (which is exactly what occurred). We actually refer to 2013 around Morgan Creek as the Year of the Coyote as it reminds us of the old Roadrunner cartoons where Wile E. Coyote would be chasing the Roadrunner, and at some point, would inevitably miss a turn, or not be able to stop, would sail off the edge of a cliff and then hang suspended in mid-air until he would eventually look down and suddenly plunge to another crash landing at the bottom of the canyon. Looking backwards, the U.S. economy faced a series of “cliffs” over the course of the year starting with the actual Fiscal Cliff in January, followed by the Taper Tantrum in May and finally the potential Government Shutdown in October, but in each case, the economy, and more importantly for this letter, the market, never looked down and never fell (in fact, the S&P 500 never fell more than 5% during the year and never fell below its 200 day moving average); the Coyote Market had been created. We can give most of the credit for the Year of the Coyote to Dr. Ben Bernanke who seemingly repealed the law of gravity using a creation that could have come right out of the Acme warehouse (where Wile E. Coyote would get all of his performance enhancing contraptions to try and catch the Roadrunner) called QEternity (or QEInfinity, whichever you prefer) as he pumped over $1 trillion of liquidity into the economy in the form of Treasury and Mortgage Bond purchases. While it is true he threatened to begin taking away the Upsidasium in May (the dreaded Tapering threat and subsequent market Tantrum), he immediately reversed course, apologized profusely, and said he wouldn’t bring it up again (until he did a few months later) when the market corrected only a few percent. All told, he threatened to Taper four times in 2013 and in all four cases the market headed down until Gentle Ben (the domesticated Ursa Major star of late 60’s TV show featuring Dennis Weaver) would reassure everyone that he really wasn’t going to take away the honey pot.
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See full Morgan Creek: Why 2014 Will be the Inverse of 2013 in PDF format here.