Mark Yusko’s 10 Surprises for 2018

Did you know that etherium was the best-performing asset in 2017, up 9,312%? Among those who hope to identify the non-consensus outperformers in 2018 is Mark Yusko. In the tradition of Byron Wien, he identified his 10 biggest surprises for 2018.

Yusko spoke at the Investments & Wealth Institute (formerly IMCA) Investment Advisor Forum in New York on January 16.

He is the founder, chief investment officer and managing director of Morgan Creek Capital Management, a hedge-fund manager based in North Carolina.

Following Warren Buffett’s victory last year in a wager that he could outperform a portfolio of hedge funds over a 10-year period, Yusko offered to make the same wager with him over the next 10 years. Buffett declined to make another wager, citing the fact that he was 87 years old.

Yusko said that he typically gets seven or eight of his predictions right. I’ve listed them below, although I’ve omitted the technical analysis that Yusko used to justify many of his predictions.

1. Actions speak louder than words

The consensus is that rates are going up, Yusko said, and it spells the end of the bond bull market. He disagreed.

Financial conditions are loose, he said, and nobody is tightening. Yusko said there is $8 trillion of debt carrying a negative yield. Yet the Fed funds rate is at a “crisis level,” he said. Why is that? The Fed is taking its balance sheet down, but if they do rates will go down. The Fed funds rate is reaching its peak and the Fed will not hike as often as the consensus expects, Yusko predicted. Indeed, he said the Fed will never lower its balance sheet because of demographics. Our aging population wants to buy bonds and won’t spend money to boost consumption and stimulate the economy. “The Fed will have to bail us out as we age,” he said. The same happened in Japan, Yusko claimed, which is now at zero interest rates, reinforced by government policy. “Rates will go down,” he said. “The long end is telling the Fed it is making a mistake. If we don’t get above 3.05% [on the 10-year Treasury] we are still in a downtrend.”

2. The bears are back in town

Yusko thinks U.S. equities will have a bad year.

If the Fed actually lowers its balance sheet, Yusko said, the market will react negatively. Fair value is “really far below” where we are now, according to Yusko. In 2017, stocks had almost the same return as in 1927. “We’ve created the biggest global debt bubble in the history of mankind,” he said. “It takes more debt to generate a dollar of GDP than ever.” Yusko said we’ve had the worst seven years of GDP growth in history. Central banks have purchased as many bonds in 2017 as they did in the depths of the great financial crisis. “Eventually that will have repercussions,” he said. Quantitative easing (QE) creates inequality through asset-price inflation. Buybacks are the “bubble juice,” he said, but that is starting to fade away. Gold is priced way less than in the bubble of 2007, he said. China saved the world in 2009 by putting $4 trillion into the world economy, and we shouldn’t expect that again, according to Yusko.

3. VIX is not dead, just resting

Prepare yourself for more volatility, according to Yusko.

Volatility was so low in 2017, U.S. equities turned in their highest Sharpe ratio (4.36) ever, he said. The average Sharpe ratio for the market is 0.5. It was the least volatile year ever, with a standard deviation of returns of 3.89, lowering the historical average from 15 to 13, he said. People are selling hedge funds and buying index funds, according to Yusko. Equity volatility is lower than bond volatility, and there has been no 10% correction in almost two years. “Everybody is all in,” Yusko said.