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DAVE JANNY SEPTEMBER ONE 2017 INVESTMENT LETTER

2017 Volume 17

“FAKE EMPIRE: THE MEN AND WOMEN WHO SOLD THE WORLD FOR

EVERYTHING NOW”

“All apologies” (quick Nirvana warning) for the long title. “All apologies” for three

song references in the title that some of my readers may not be familiar with. No

apologies however for the rather dramatic nature of the title. My Investment

Letters are intended to explore some of the “global macro” economic and market

trends that can have future implications on your financial future. The dramatic

nature of the current title is intended to make you take notice of some of the

alarming and unsustainable trends that you’ll need to be aware of now and in the

coming years that can have consequences on the financial world we live in. I want

to make you contemplate these trends in the context of your personal lives,

finances and careers and I want to try to help you to be prepared for the

inevitable adverse consequences of what we’re seeing on the global economic

scene. I know that sounds rather ambitious, but give me a chance.

Not much has transpired since my last Investment Letter “Roadrunner in a Mad

World” (thanks for your overwhelming interest and appreciation); as far as the

stock market is concerned anyway. Despite nuclear provocations and threats as

well two major U.S. hurricanes and ongoing political and geopolitical tensions,

incredibly not much happened in the stock market. As I mentioned above, this

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Letter will focus less on short term market posturing and serve more as a “big

picture” guide to put into perspective what has transpired since the March 2009

stock market bottom and allude again to the dangers and warning signs being

generated in this late-cycle phase of where we are in the investment world. Past

recent Letters have spent much time talking about market overvaluation, over-

indebtedness in many global sectors and economies and a multitude of troubling

technical market trends like volatility suppression and the rush to passive ETF

index investing. These warning signs show that there is a lot of underlying risk in

the market, the timing of the realization of that risk is unknown. The markets may

“hang in there” for longer than I think because of the unusual nature and

rationale for the advance (read on for rationale). Many investors are unaware of

the risks so I hope this Letter helps with at least the recognition of those risks. I

urge you to take a close look at my website at

http://fa.morganstanley.com/david.janny/ under “view all documents” from the

“From My Desk’ section of the site to view my past Investment Letters. Now onto

“Everything Now”.

FAKE EMPIRE

“Fake” is a term that has recently been given new significance and has garnered

much attention as a result of the outbreak of the epidemic of “fake news”. “Fake”

is an adjective that implies that something is not really true. “Fake Empire” is a

song from The National who are one of the more influential bands on the

indie/alternative rock scene. Here’s a comment from genius.com on The

National’s song “Fake Empire”:

“The opening track of The National’s 2007 opus, “Fake Empire”

describes the hedonism and escapism of a culture lost to excess

in the wake of its diminishing status as a world superpower.

Simply, the everyday demands of life are too difficult for us to

really care about America’s sociopolitical climate, therefore we

are “half-awake” to these concerns in our “fake empire.”

It sounds to me like The National, an American band, were opining on their view

of the U.S.. I’d like to take a more globalist view of that line of thinking and extend

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the use of “Fake Empire” to the broader global current state of affairs of

capitalism. Here’s the definition of “capitalism” by the Google dictionary:

“an economic and political system in which a country's trade and

industry are controlled by private owners for profit, rather than

by the state”

In what may be a too simplistic and somewhat naïve yet relatively accurate take, I

would theorize and generalize that capitalism has been the driving force in

economic growth in more recent human history. Free trade and enterprise in

democracies and China (it requires its’ own category) have been responsible for

much cumulative wealth creation. My feeling is that something shifted over

recent years; the shift is the level of “state” intervention. The shift has rapidly

accelerated since the financial crisis that started in 2007. I say started because I

don’t believe the financial crisis is finished; just temporarily delayed. The shift is

not good and does not bode well for the future. In the definition I used above, the

term “rather than by the state” conspicuously jumps off the page for me and thus

conjures the word “fake”. We have anything but “rather than by the state”

economic and market activities taking place across the globe.

Because of capitalism’s creation of enormous quantities of debt “the state” has

had to step in more and more to hold things together. Some people politely call

this intervention, but I think history will end up calling it hijacking. The “state’s”

intervention has created more common concepts like “crony capitalism” where

the beneficiaries of the intervention are less widespread and more selected and

concentrated. Economic outcomes are more dictated by the ever-expanding size,

reach and dependence on and of the government or “the state”. Since the

financial crisis, “states” around the world have been forced to create more and

more debt to bandage the problems and keep the economic ball rolling. As I

detailed in my last Investment Letter “Roadrunner in a Mad World”, current

estimates of global debt according to Strategic Investment stand at somewhere

around $217 trillion. The number is so staggering and mind-numbing that it

doesn’t even create much of an emotional reaction anymore. In order to create

economic growth more and more debt needs to be created. Attitudes towards

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debt have gotten more “casual” all around the world while dependence on the

debt creation becomes more essential yet dire to individuals’ continued

accumulation of goods. I vividly remember Ben Bernanke and other politicians

and members of the state essentially telling us after the financial crisis that “we

need you to buy more stuff”. That was the patriotic thing to do in a consumer

dependent economy.

The “empire” that capitalism has created looks great when measured by global

stock and bond markets. Market cheerleaders continue to successfully extol the

wonders and potential of the markets to TINA (There Is No Alternative) investors.

On the other hand, the economic progress since the financial crisis has been slow

and disappointing and is in stark contrast to the previously mentioned financial

markets. Don’t believe the recently oft-used term “goldilocks”. Goldilocks is a

fairy tale. In fairy tales things end “happily ever after”. In real economies, natural

and healthy “cycle” dynamics are allowed to occur. In a “fake empire” not so

much (more on this in a little bit). That dichotomy between markets and

economies cannot continue for too much longer. “Fake” therefore is a word that

helps me best describe the current “empire” of capitalism.

THE MEN AND WOMEN WHO SOLD THE WORLD

Some of you may remember David Bowie’s 1970 song “The Man Who Sold The

World”. If you don’t remember that version, you may be more familiar with

Nirvana’s 1993 acoustic “cover” version from MTV’s “Unplugged”. If you don’t

remember that one, my suggestion is to check it out on YouTube.

I have exercised some literary license to adjust the title for my Investment Letter

purposes to “The Men and Women Who Sold The World”. For those of you who

regularly read my Investment Letters, I hope you may be suspecting a central

banker reference; those suspecting readers would be right. To be “politically

correct” I adjusted and expanded the title to include central bankers like Janet

Yellen.

“Sold the world” or “selling the world” sounds like an incredibly ambitious,

difficult and serious undertaking. The phrase reminds me of the 2/15/99 Time

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magazine cover “The Committee to Save The World” that pictured Alan

Greenspan, Robert Rubin and Larry Summers. It represented and lauded the

efforts of central bankers to resolve and ameliorate the collapse of Long Term

Capital Management in the aftermath of the Asian and Russian financial crises in

1998. For a brief but informative review that ties the “saving” of the financial

world in 1998 to the financial crisis of 2008 check out this link from the blog

“Mostly Economics”:

https://mostlyeconomics.wordpress.com/2016/05/12/the-committee-to-save-

the-world/

That was the blatant start of the “fakeness” and the creation of terms like the

“Greenspan Put” and “Bernanke Put”. In today’s world the tradition is being

carried on at a breakneck and frightening pace. As a matter of fact, today’s

interventions don’t even need a real excuse, the interventions are pre-emptive. In

today’s world it appears to me that central bankers have become the main agents

of the “state” and “the men and women who sold the world”. In June J.P. Morgan

estimated that global central banks have acquired around $18 trillion in bonds or

about 1/3rd of the entire $54 trillion global bond market. They have purchased

plenty of bonds but also stocks. Yes stocks, and they’ve been buying a lot of them.

I’ve been chronicling these trends all year long in my Investment Letters. Here’s a

quick recap:

- As I referenced in my last Letter “Roadrunner in a Mad World”, the BOJ

(Japan’s central bank) owns 75% of the Japanese ETF market and as a result

will be the major shareholder in 55 companies by the end of 2017. That’s in

addition to owning (according to Japan Macro Advisors) approximately

43.4% of the Japanese government bond markets (JGBs) that I mentioned

in my July 2017 Investment Letter titled “Suspicious Minds: The Weight and

the Waiting”. The Japanese have been the trendsetters in central bank

intervention. Their stock market peaked around 1990 at about incredibly

twice the level of where it sits today (according to investing.com) as the

Japanese have been engaged in a massive deflationary battle ever since.

They too were motivated to aggressively “step up” their intervention after

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Ben Bernanke’s “bold” post-financial crisis intervention. They serve as a

model for the potential “Japanification” of the world.

- The U.S. Federal Reserve has added over $4 trillion of treasury and

mortgage bonds to its balance sheet since the financial crisis on Bernanke’s

kickoff to global QE. The Fed has had opportunity in the last couple of years

to tighten policy (especially with the cover of ECB and BOJ QE) but has only

managed a couple of minor interest rate hikes thus far and despite threats

to reduce the balance sheet have actually sounded dovish again.

- Mario Draghi’s ECB is still buying $60 billion euros a month of European

sovereign and corporate bonds. Draghi has recently been reluctant to

unveil plans to taper and eventually end the bond buying that has created

epic distortion in the European bond market including approximately $8.5

trillion of “negative yielding” bonds around the world and a stunning

measly 2.4% yield on the European High Yield Index I referenced last time.

- In my last Letter I referenced the Mises Institute’s claim of the Bank of

England (England’s central bank) owning between 25-30% of the UK’s

sovereign bond market.

- China as I mentioned earlier deserves its own categorization. The Chinese

have notoriously been actively supporting their stock market to maintain

investor calm and stem capital flight. Although I haven’t been writing about

China much in this year’s Investment Letters, the “credit explosion” in

China since the financial crisis has been historic by many multiples in its

incredible size. Stay tuned I plan on focusing on this in greater detail in the

near future.

That is obviously a lot of “state” intervention which has certainly simultaneously

“juiced” global asset markets while at the same time created an addiction that

will be hard to break without some potentially negative consequences. Can you

say “fake”?

Rising asset market prices have been met with joy by the investor class. Global

politicians and central bankers point to the rise in stock averages as confirmation

of “a job well done”. Donald Trump is the latest example, taking credit for the

advance in the U.S. market since the election. If I were Trump I’d send a “thank

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you” note to ECB president Mario Draghi, who in my opinion has been the single

largest factor in the global asset market rally this year. Draghi’s gargantuan and

irrational “whatever it takes” QE policy has lifted all markets. It has also helped

create approximately $8 trillion worth of negative yielding bonds I mentioned

earlier. “Zero rates” were not “enough” and central bankers explored the

unchartered territory of “negative interest rates”. It’s hard to even say “negative

interest rates” because it doesn’t even make any sense.

All the while, wages have not increased much. Central bank attempts to create

“inflation”, most notably in wages have failed. Those that have not been privy to

the benefits of asset price inflation have been forced to borrow to keep up with

the “necessary” consumerism required by global economies to maintain a shallow

but positive economic pace. Income and wealth inequality has substantially

widened under the “QE” regime. Thus the whole ‘party” has been expensive both

in terms of central bank efforts and consumer, corporate, government and

municipal balance sheets. The “hangover” should prove to be painful.

To try to make you feel better (sarcasm alert) I’ll leave you with some quotes

from some of “the men and women who sold the world”:

Mario Draghi quotes from 8/23/17 in a speech in Germany:

"A large body of empirical research has substantiated the success

of these policies in supporting the economy and inflation, both in

the euro are and in the United States.”

"Policy actions undertaken in the last 10 years in monetary policy

and in regulation and supervision have made the world more

resilient."

Mario if we’re so “resilient” why record QE this year?

Janet Yellen quote in a 6/27/17 speech at the University of Michigan:

“Will I say there will never, ever be another financial crisis? No,

probably that would be going too far. But I do think we’re much

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safer and I hope that it will not [happen] in our lifetimes and I

don’t believe it will,”

At least she didn’t definitively rule out another financial crisis.

Here’s a series of former Federal Reserve Chairman Ben Bernanke quotes that are

particularly interesting and pertinent in light of today’s Letter and today’s

investment world that I had included in my September 2016 Investment Letter

titled “Nirvana, Milli Vanilli and Moral Hazard”:

“As we try to make the financial system safer, we must inevitably

confront the problem of moral hazard.”

“Most of the policies that support robust economic growth in the

long run are outside the province of the central bank.”

“Only a strong economy can create higher asset values and

sustainably good returns for savers. There are limits to monetary

policy.”

“Market discipline can only limit moral hazard to the extent that

debt and equity holders believe that, in the event of distress, they

will bear costs.”

Central bankers and investment markets certainly appear to be acting contrary to

Bernanke’s above directives and wisdom. This leads me back to my September

2015 Investment Letter titled “We Won’t Get Fooled Again”; I created what I

called “The Central Banker Play Book”. It’s time to pull out again:

CENTRAL BANK PLAYBOOK

1. Announce “emergency stimulus measures” intended to help

revive economic growth.

2. Keep interest rates as low as possible, even zero or negative,

and buy your own government bonds at a staggering pace.

3. Force stock markets to go up to make people feel better,

which you think should in turn help economic growth. If you

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need to, blatantly buy stocks and restrict selling in the market

(e.g. China). Watch stock markets very carefully.

4. Devalue you currency to give yourself a brief boost to

exports. This boost should last until your neighbor does the same

thing.

5. Give “forward guidance” as to when you will try to

“normalize” conditions even though you know this will be

difficult to accomplish. Talk about how “transparent” you are.

6. Keep saying things will be better to try to “fool” investors

and consumers.

7. Know that your solutions are temporarily only helping the

rich and not really helping and probably hurting the middle and

lower income citizens. Don’t admit your hurting conservative

“savers’.

8. When economic growth doesn’t materialize, pledge “to do

everything possible” and do it all over again.

I wrote that two years ago, incredibly “the men and women who sold the world”

are still at it. I’ll add two addendum items that have become part of the playbook

since then:

9. Recessions and economic cycles are not allowed.

10. Stock market corrections are not allowed.

A “fake empire” for sure. Keep in mind that a “paper profit” on an asset is not

really a “profit” or “real wealth” until the asset is sold. I’m afraid that the legacy of

QE will be asset bubbles, debt bubbles and income and wealth inequality.

EVERYTHING NOW

“Kicking the can down the road” has displaced soccer as the world’s most

popular sport. Politicians, central bankers and consumers require “everything

now”. “Everything Now’ is perhaps my favorite new song of 2017. It’s a song by

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the Canadian band Arcade Fire. It is an anthemic, rather addictive and upbeat

pop-grooved ode to our “Everything Now” society. If you’ve heard it, you know

what I’m talking about, if not definitely try to listen it. I’ll share a couple of verses

to give you a feel;

“I pledge allegiance to everything now

Every song that I've ever heard

Is playing at the same time, it's absurd

And it reminds me, we've got everything now

We turn the speakers up till they break

'Cause every time you smile it's a fake!

Stop pretending, you've got…

(Everything now!) I need it

(Everything now!) I want it

(Everything now!) I can't live without

(Everything now!) I can't live without

(Everything now!)

(Everything now!)

If you’re not “feeling it” yet, I’ll try to show to you how accurately the lyrics

describe today’s world. Not so ironically, Arcade Fire says “every time you smile

it’s a fake”. The implication I believe is that “everything now” is not always the

best thing for us.

If you’re a parent you’ll understand the concept of “tough love”. I’m 56 years old

and I have 5 kids so I’ll portray myself as somewhat of an expert on the topic. It

seems to me to be that today’s generation of parents, not too dissimilar to

politicians and central bankers, have had a difficult time grasping the concept of

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“tough love” but rather have succumbed to the more “fun” concept of

“everything now”. Short term appeasement at the expense of sensible long term

planning has become the order of the day. I’ll walk you through some examples.

Last week the markets had a favorable reaction to the “debt ceiling deal” that

Trump made with Democrats. Putting aside the fact that we needed to figure out

a way to help the victims of both hurricanes, extending the “debt ceiling

deadline” was a classic “kick the can down the road” and “everything now”

action. There have even been calls for the elimination of the “debt ceiling” in its

entirety. In my view, at a minimum, the “debt ceiling” at least provides a “speed

bump” on the way to the eventual lifting of the “ceiling”. However, when will we

ever tie some sort of fiscal restraint to the “deal”? In our “everything now” world

that doesn’t make any sense. Short term political interests are better served

“giving in” now rather than exercising any long term financial sense. This is best

illustrated by comments from then-Senator Barrack Obama from a 2006 speech

that I had included in my May 2016 Investment titled” Stuck in the Mud of Debt: I

Hope It’s Not Quicksand”:

“The fact that we are here today to debate raising America’s debt

limit is a sign of leadership failure. It is a sign that the U.S.

Government can’t pay its own bills. It is a sign that we now

depend on ongoing financial assistance from foreign countries to

finance our Government’s reckless fiscal policies. Over the past 5

years, our federal debt has increased by $3.5 trillion to $8.6

trillion. That is ‘‘trillion’’ with a ‘‘T.’’ That is money that we have

borrowed from the Social Security trust fund, borrowed from

China and Japan, borrowed from American taxpayers. And over

the next 5 years, between now and 2011, the President’s budget

will increase the debt by almost another $3.5 trillion.”

“Increasing America’s debt weakens us domestically and

internationally. Leadership means that ‘‘the buck stops here.’’

Instead, Washington is shifting the burden of bad choices today

onto the backs of our children and grandchildren. America has a

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debt problem and a failure of leadership. Americans deserve

better.”

“I therefore oppose the effort to increase America’s debt limit.”

Later on President Obama did an exemplary job of raising the debt of the country

to close to $20 trillion. It doesn’t seem like President Trump will fare much

differently with many of his up-front deficit spending proposals.

There are plenty of other examples, how about North Korea? This is not a new

problem. North Korea’s nuclear ambitions have gone unchecked for probably at

least 25-30 years. The easiest option all along the way was not really dealing with

the problem. Here we are today with serious nuclear tests occurring with threats

of use of nuclear force.

How about pensions? I’ve written extensively about the massive underfunding in

public and private pensions. Why spoil today’s “party” and try to deal with the

issue today? We’ll just “kick the can down the road” and worry about it later, by

the way when it will be a much bigger problem. Entitlements? I’ll avoid that one

just like the politicians do.

Draghi and the Europeans have been exceptional “kick the can” players; how

many times has Greece been bailed out? I lose track. Draghi’s aforementioned

reluctance to even talk about “tapering” QE, much less taking action, is another

great example.

Then we have consumers. According to CNBC consumer debt recently exceeded

the pre-financial crisis levels and is just under $13 trillion. That debt creation was

a big part of the problem that created the financial crisis in the first place. This

record has transpired despite the extinguishment of much mortgage debt. “Rose-

colored glasses” observers point to low rates as an excuse for the excessive debt.

The last time I checked, the rates on credit card, student loan, auto and mortgage

debt are still relatively very high in a zero interest rate world savers are faced

with. Many consumers in the U.S. are addicted to debt to live the “everything

now” consumer lifestyle. I strongly feel that as a society we did not learn the

needed lesson of excessive debt in the financial crisis. God forbid, despite central

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banks’ best efforts, the U.S. and global economy goes into a recession. Economics

“101” has not been re-invented; there will be a recession in the offing. Maybe

sooner than you think since we are in the 9th year of this weak economic recovery.

Additionally, another factor to consider is that despite central bankers’ failed

extreme desire to increase inflation, inflation keeps undershooting; unless you

consider health care and education costs. Don’t get me started.

I believe that another reason for the ingrained societal “everything now” attitude

is the “instant gratification” nature of this 24/7 technology/media age we live in.

News, work, purchasing ability and entertainment amongst other things are

always at the disposal of our finger tips. We are overwhelmingly an “everything

now” society. This won’t change soon, but the need to make prudent decisions

will always be necessary.

PRAYERS, SUPPORT AND BROKEN WINDOWS

As I write this, Irma has finally passed Florida, thankfully not as bad as the

potential but still tragic. Two large storms have harmed many of our citizens and

our thoughts, prayers and support for them is critical at this point. Ironically,

Harvey and Irma in some ways have brought us closer together as a nation. In the

future I hope and pray that it isn’t tragedy that is the only unifying force.

There’s an economic concept known as the “broken windows fallacy”. Simply put,

you don’t create economic growth by intentionally damaging something or

“breaking windows”. Yes there will be rebuilding efforts in Texas and Florida, but

on a whole the events are not an economic “positive”. There will be winners and

losers in certain sectors. One additional complication is that many of the people

impacted, particularly in Texas, were not covered by the necessary flood

insurance. Sorting out reimbursements with the government and insurance

companies will be a long and confusing process and result in settlements that may

prove underwhelming. According to CNBC, Goldman Sachs just cut their Q3 GDP

forecast by 1%. I’m sure there will be more negative revisions to come. I’m afraid

any economic bounce will be less and come later than some are currently saying.

PORTFOLIO REVIEW

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Hopefully you can see that we’ve created a central bank “trap” that will be

difficult to escape from. The longer it drags on, the more crippling the fallout will

eventually be. “Fake Empire” truly describes the nature of the current economic

and financial “state of affairs”. Yes, “state” was an intended pun. We can’t

continue to live with an “everything now” mentality. The sooner we decide to

“fix” things rather “delay” things the better off we will be in the long run.

What to do? Let’s talk. If we haven’t spoken or reviewed your portfolio, let’s do

so. Preparation will be critical. For the moment, “the men and women who sold

the world” continue to prop up global asset markets, but the risks are mounting.

The investing climate could change gradually or there could be some unexpected

short term shocks that wouldn’t be surprising given all the warnings I’ve been

detailing. Thanks for reading my Letter, let me be of help.

David Janny

Senior Vice President

Senior Portfolio Manager

Financial Advisor

NMLS# 1279369

Morgan Stanley Wealth Management

500 Post Road East

3rd Floor

Westport, CT 06880

203 221-6093

Visit my website http://fa.morganstanley.com/david.janny/

Connect with me on LinkedIn: https://www.linkedin.com/in/david-janny-ba2734115

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depending on market conditions. If sold in a declining market, the price you receive may be less than your original investment.

Unlike bonds and stocks, precious metals do not make interest or dividend payments. Therefore, precious metals may not be

suitable for investors who require current income. Precious metals are commodities that should be safely stored, which may

impose additional costs on the investor. The Securities Investor Protection Corporation (SIPC) provides certain protection for

customers’ cash and securities in the event of a brokerage firm’s bankruptcy, other financial difficulties, or if customers’ assets

are missing. SIPC insurance does not apply to precious metals or other commodities.

Asset allocation does not guarantee a profit or protect against a loss in a declining financial market.

Past performance is no guarantee of future results.

NASDAQ Composite Index is a market-value-weighted index of all NASDAQ domestic and non-U.S. based common stocks listed

on NASDAQ stock market. An investment cannot be made directly in a market index.

S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock

market. An investment cannot be made directly in a market index.

The NYSE Arca Gold BUGS Index, also known as the AMEX Gold BUGS Index, is a modified equal dollar weighted index of

companies involved in major gold mining. The index was designed to give investors significant exposure to near term

movements in gold prices by including companies that do not hedge their gold production beyond 1½ years. The index was

developed with a base value of 200 as of March 15, 1996.

Morgan Stanley Smith Barney LLC. Member SIPC. CRC 1893787 09/17