Waiting on the Fat Pitch

Geopolitics continue to call the tune as markets move on every twitter feed out of the Ukraine. The movements of troops are moving the troops on Wall Street as nervous investors look to stay ahead of the machination of politicians in the eastern bloc. This is the nervous time of year after all. Investors are very cognizant that summer markets are very thin and can move on very little news as traders sun themselves on beaches before the kids head back to school. Back to school usually brings some sort of stress test as Se[ptmeber and October have a history of ugly turns in the market. It is no wonder we are seeing investors such as George Soros and David Tepper hedge long positions in the stock market. With valuations at such high levels, troops at high alert and investors highly anxious about what the fall may bring it may be a prudent strategy to continue to build investing defenses. Even Warren Buffet who hates carrying substantial amounts of cash on his books is currently at his highest level of cash in over 40 years.   http://www.bloomberg.com/news/2014-08-04/buffett-waits-on-fat-pitch-as-cash-hoard-tops-50-billion.html

One of Mr. Buffett’s investing axioms is, much like a baseball batter with unlimited strikes might do, is to wait for the fat pitch. With over $50 billion on hand at Buffett’s Berkshire Hathaway that is one fat pitch indeed. Below by way of dshort.com comes Buffett’s favorite market indicator – Market Capitalization to GDP. As a signal the market is overbought when the indicator breaks 100% and is oversold when it goes below 60%. We are currently at 126% of GDP. Markets can advance farther than one thinks but this indicator is certainly flashing a yellow caution light.

 

The above chart, also from dshort.com, is the Q Ratio. The Q Ratio was developed by James Tobin, Nobel Laureate from Yale University. The Q Ratio measures the combined market value of companies to their replacement cost. A ratio below one indicates that the value of the company’s stock is cheaper than replacement cost while a ratio higher than one indicates that the company’s stock value is higher than the replacement cost. From this one can see that markets and investors don’t listen to yellow caution lights and sometimes just sail on through. The Internet Bubble of 2000 pushed right on through the highest levels of Q Ration ever recorded. Flashing caution at over 1.0 this metric currently stands at 1.17. High levels but one does not know when a bubble breaks.

Having aid that we do believe that the Federal Reserve’s action of continued monetary policy have induced these high levels of asset prices. Any further reduction in monetary heroin may induce less than euphoric feelings from the marketplace. In July the reduced asset purchases began to have an effect on markets and those purchases are planned to cease in October of this year. We continue to expect volatility to increase into that time frame and prepare for the opportunities that may rise from the change in monetary policy.

Equity markets have seen increased volatility, which from our perspective, limits upside potential in markets. Equity markets have seen higher upside since 2008 when markets are stable and not volatile. We believe that this volatility will continue into the fall of 2014. The Ukrainian situation and Portuguese banking crisis presented volatility and a selloff of risk in equity markets. That extended selloff was afforded a bounce in prices this past week. That bounce may have run its course. Friday’s action in the market provided clues that the bulls short run has ended as bears took control in the afternoon on Friday at critical resistance points. This week may be critical in the future near term course of the market as everyone awaits Janet Yellen’s Jackson Hole speech on Friday.

We continue to use small caps as our map while US Treasuries and Gold continue to be our risk temperature gauge. For the moment 1960/68 is key resistance in the S&P 500. If the bulls can leap above this level the run can continue. On the downside, the Russell 2000 needs to hold 1100.  Also keep an eye on the VIX index. As it spikes the Fed may try to calm fears.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on August 16, 2014 at 8:46 am  Leave a Comment  
Tags: , , , ,

Contagion

Volatility is back and so are the caution flags. You know the list. It includes geopolitical issues such as the Ukraine and Gaza. Economic issues like inflation and jobs reports. A default from Argentina and a runaway virus like something out of a science fiction movie. The thought of an Ebola contagion was not the only contagion making the rounds. A European banking contagion may have stoked more fear this week than the Ebola Virus. Portuguese banking issues sent European stock markets reeling.

One issue that has had our attention for weeks is the drawdown of Federal Reserve purchasing in the marketplace. Each month the Federal Reserve has cut back its purchases by $10 billion in an attempt to exit the monetary easing business. That tapering of purchases has not had an immediate effect on the market until this month. The Fed’s purchases, while steady, actually had an increasing effect as the supply of bonds shrank along with the US fiscal deficit. The Fed was actually purchasing a larger percentage of supply each month. This month is the first month of the tapering where the percentage of Fed purchases actually shrank and it may not be a coincidence that we also saw the market shrink.

How bubbly are we? From Richard Fisher President of the Dallas Federal Reserve comes this speech given on the campus of the University of Southern California on July 16th of this year titled Monetary Policy and the Maginot Line.

To get a sense of some of the effects of excess liquidity, you need look no further than Neil Irwin’s front-page, above-the-fold article in the July 8 issue of the New York Times, titled “From Stocks to Farmland, All’s Booming, or Bubbling.” “Welcome to … the Everything Bubble,” it reads. “Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals.” Irwin’s comments bear heeding, although it may be difficult to disentangle how much these lofty valuations are distorted by the historically low “risk-free” interest rate that underpins all financial asset valuations that we at the Fed have engineered. http://www.dallasfed.org/news/speeches/fisher/2014/fs140716.cfm

Just about every asset class is overvalued but if history is our guide as the Fed exits QE bonds will hold steady while equities put in a bit of a retreat. For hints on that retreat we refer to the small cap space as the canary in the coalmine. The Russell 2000 is showing signs of a classic double top. A double top is a cute way of saying that we got to the highs twice and lacked the conviction to break through. We now need to test the lows of its recent range and the bull’s conviction. The Russell is now at 1114.89. A close decisively below 1090 would indicate a move to 970. A move 12.9% lower which would develop rather quickly. Keep one eye on the Russell 2000.

Fisher wants less accommodation but Yellen, as seen in her Humphrey Hawkins testimony below, plans on being quite accommodative. In this battle Yellen wins for now. Look to Fisher for the truth but look to Yellen for the Fed’s next move. The market seems to be siding with Fisher for now and fears that the Fed may be behind the curve.

“We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates,” … “I think the forward guidance that we have provided in the policies that we have put in place are providing a great deal of accommodation to the economy to make sure that it is on a solid trajectory.” Janet Yellen – Humphrey Hawkins Testimony Congress July 2014 http://www.cnbc.com/id/101836922

Small caps are our map while US Treasuries and Gold continue to be our risk temperature gauge. Also keep an eye on the VIX index. As it spikes the Fed may try to calm fears.  

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on August 2, 2014 at 2:25 pm  Leave a Comment  
Tags: , , , , ,

Riding the Waves

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

For years our mantra has been – build investing scenarios and trade accordingly. It is akin to the Boy Scout motto. Be prepared. Lloyd Blankfein, the Chief Executive Office of Goldman Sachs, states it very well in the above quote when he compares his firm to contingency planners. Indeed, he is correct in that we cannot predict the future but what we can do is prepare for it. In this preparation we are currently finding the lack of volatility to be very unsettling. Less and less volatility tells us we may be overdue for an approaching storm. Let’s take a look at the facts from the folks over at the Bespoke Investment Group. On June 17th they released this research note.

In fact, it has been two months (42 trading days) now since the S&P 500 last had a move up or down of 1% or more.  To put that in perspective, you have to go back nearly 20 years to 1995 to find a period where the S&P 500 went longer without a move of that magnitude.

 Since 1928, there have been 30 other streaks that lasted longer than 40 trading days.  While extended streaks have been rare in the last twenty years, it hasn’t always been that way.  For example, from the early 1950s through the early 1970s, there were numerous periods of extended calm in the market.  In fact, the years 1963, 1964, and 1965 each saw streaks of more than 100 trading days without a 1% move (the 1965 streak ended in February 1966).

http://www.bespokeinvest.com/thinkbig/2014/6/17/1-moves.html

Could we be in for an extended period of calm in the markets as the one that took place from the early 1950’s until the inflation years of the early 1970’s? Perhaps, but we feel that the pace of change is accelerating in the Internet Era and too many high level officials have interests in seeing higher volatility. Let’s look at what some of those high level officials have been saying in recent months.

VOLATILITY – Resurgence?

Over the last two months we have seen a steady parade of Investment Bankers, CEO’s and Federal Reserve officials, both past and present, come to the microphone to argue that volatility must rise. For investment bankers and CEO’s of financial trading firms volatility is a must. Banks like CitiGroup, Goldman Sachs and JP Morgan need volatility in order to provide value to clients and make profits. Here is a partial list of the lineup of bankers preaching about the current lack of and need for volatility.

On May 7th of this year Jeremy Stein, in one of his last speeches as a Federal Reserve governor, warned that the central bank may face more bouts of market volatility as it winds down the most aggressive easing in its history.

Some investors may be “underestimating the degree of uncertainty about the future path of policy and are placing levered bets accordingly,” Stein said yesterday in a speech to the Money Marketeers of New York University. “So we may have some further bumps in the road as this all plays out.”

In response to an audience question, Stein said “it’s important that we not get goaded into thinking we’re responsible for minimizing market volatility.” -Bloomberg 5/7/14

We see this as a not so subtle shot across the bow. We take this as a warning that the Fed knows that volatility is coming as they exit from Quantitative Easing (QE) and that they want markets to be prepared. Stein’s answer to the audience’s question seems to intimate that given renewed volatility upon their exit the Fed may remain on the sidelines and allow greater volatility.  A 10% correction could easily morph into a 20% correction as the Fed tries to remain on the sidelines in the event of a market retreat.

Comments from FOMC members carry different weights. New York Federal Reserve (NYFRB) President Bill Dudley’s comments carry more weight than most. While we believe that volatility will rise and that the Fed may be encouraged to sit on the sidelines at some point the Federal Reserve will intervene and backstop any market slide.  In late May Dudley made comments that suggested that very same concept. Dudley volunteered that the Fed will be more aggressive in raising rates if markets allow and less aggressive if they do not. From that comment we believe that Dudley infers that the market will be calling the tune and the Fed will apply the brakes or the gas depending on the market’s reaction to Fed policy. Welcome to Goldilocks monetary policy. Not too hot. Not too cold.

Jon Hilsenrath is considered to be a mouthpiece for the Federal Reserve and is charged with helping get the committees thoughts and the correct perception of those thoughts into the mainstream. In a piece in the Wall Street Journal (WSJ) on June 3rd of this year Hilsenrath proffered a belief that Federal Reserve officials, looking out at mostly calm financial markets, are starting to wonder whether tranquility itself is something to worry about.

Other measures of risk aversion and market volatility show an especially striking sense of investor calm. The VIX, which tracks expected stock-market fluctuations based on options trading, has gone 74 straight weeks below its long-run average—a run of steadiness not seen since 2006 and 2007.

Moreover, the extra return that bond investors demand on investment-grade corporate debt over low-risk Treasury bonds, at one percentage point, hasn’t been this low since July 2007. The lower this “spread,” the less risk-averse are bond investors.

The worry at the Fed is that when investors become unafraid of risk, they start taking more of it, which could lead to trouble down the road.

http://online.wsj.com/articles/fed-officials-growing-wary-of-market-complacency-1401822324?KEYWORDS=hilsenrath

 By way of none other than Lloyd Blankfein, CEO of Goldman Sachs, comes his take on the lack of volatility.

While stock market volatility has dropped to a seven-year low as major indexes continuously rise to record highs, that blissful investing state can’t last forever, … The luxury of a steady, calm, quiet market” might continue for a period, but will ultimately halt,…

“At the end of the day, it’s not a normal condition to have interest rates at zero,”… “Eventually people will acknowledge higher [economic] growth. Money as a commodity will start to cost something again. . . . That in itself will produce a shock to the market.”– Lloyd Blankfein CNBC Interview June 11, 2014 http://www.cnbc.com/id/101749844

With great complacency comes the possibility that the market will be surprised by an exogenous event and given the degree of complacency the greater the impact of that event as investors are not positioned accordingly. If everyone is on one side of the boat when the wave hits the greater the chance that one or more get thrown overboard.

The central theme here is that investors should be expecting an increase in volatility as the Federal Reserve tries to exit its loose monetary policy. We expect trading bands to widen over the coming months as Fed officials warn of approaching volatility. The bankers are asking for it and the Fed is ready to let it happen. We intend to be prepared.

INFLATION VS DEFLATION The Debate Rages again

The inflation trade is making its way back to the forefront of investor’s minds in the aftermath of the Federal Open Market Committee meeting in June. In Chairwoman Janet Yellen’s press conference traders got the feeling that the FOMC is a bit too complacent when it comes to recent inflation statistics which seem to be heating up.

When inflation talk heats up we look to gold and the 10 Year US Treasury for clues. Traders bid up the inflation trade across asset classes as gold/silver rallied and Treasury yields rose while the yield curve steepened. Is inflation back? Gold bounced off of its lows very aggressively this week in the aftermath of the FOMC meeting. We may now be looking at the top end of that range to see if that can repel the gold bulls. $1400 is going to be a key number. Can it break out of its recent range of $1200-$1400? A break through $1400 on the upside would ignite a new round of short covering and perhaps foretell a move back into inflation trade winners. US 10 year Treasury yields are also up against resistance and at key levels.  Over the course of the next quarter we will be keeping a close eye on gold and the 10 Year US Treasury. If investors begin to move back towards the inflation trade things could change quickly. A move towards rising inflation would push us to reduce bond holdings and garner a larger allocation towards precious metals and oil producers.

VALUATIONS

BIRINYI

Laszlo Birinyi called the bottom in stocks in March 2009 and has remained unabashedly optimistic ever since. Birinyi has an amazing track record and is considered the consummate bull.  Last month he was quoted by the WSJ as saying that he felt that the bull market may be its last phase – the exuberance phase.

http://blogs.wsj.com/moneybeat/2014/05/27/laszlo-birinyi-sp-500-to-1970-this-year/

GRANTHAM

Another voice that we always stop and listen to is that of Jeremy Grantham founder of Grantham Mayo and manager of over $100 billion in assets. In an interview in Fortune Grantham and his crew over at GMO in Boston were asked about their extensive work on bubbles going back throughout investing history. Grantham’s research indicates that most bubbles go to at least two standard deviations above the market’s mean valuations. Grantham feels that a bubble in the overall market would not exist until the S&P 500 hit 2,350 although his models suggest negative returns over the next 7 years based on current valuations.

We do think the market is going to go higher because the Fed hasn’t ended its game, and it won’t stop playing until we are in old-fashioned bubble territory and it bursts, which usually happens at two standard deviations from the market’s mean. That would take us to 2,350 on the S&P 500, or roughly 25% from where we are now.

We invest our clients’ money based on our seven-year prediction. And over the next seven years, we think the market will have negative returns. The next bust will be unlike any other, because the Fed and other central banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before. Assets are overpriced generally. They will be cheap again. That’s how we will pay for this. It’s going to be very painful for investors.

Another note on current market valuations came to us just last week from JP Morgan that shows the current level of Price Earnings ratio of the S&P 500 based on trailing earnings. The latest numbers show that the market has only been more richly valued on this metric in 10% of its history. As you can see from the chart below that shows P/E levels since 1983 a good portion of that 10% happened between 1996 and 2007. That timeline encompasses the period that Alan Greenspan cited irrational exuberance in the stock market, the Internet Bubble and the Real Estate Bubble of 2007. Are we just in a phase in the market where Federal Reserve polices engender higher P/E ratios? Could markets go even higher? We think that the answer to both is yes but we must be prepared if the answer to those questions turns out to be no. Two things that money managers are taught from the time they can crawl and considered always dangerous to believe. 1. It is different this time. And 2. We are in a period of permanently higher price levels. It is never different and nothing is permanent.

 RIDING THE WAVES OF VOLATILITY

The market continues to make new highs even as investors seem as reluctant as ever to buy those new highs. Small caps may hold the key to the market. We have noticed of late that investment managers have been piling into Mid Cap S&P stocks. That gives them the chance to catch up if they have been underperforming the market but are not fully exposed as they would be if they piled into small caps and their higher risk profile. While large caps have risen back to all time highs small caps have not quite confirmed that move. What we may be seeing here is that institutional investors are forced to invest client’s money and are placing that money into safer assets like mid and large cap stocks while a stealth bear market takes place underneath in small caps. When confusion reigns we turn our eyes to the bond market. The bond market is not playing along with a new high in equities as 10 Year US Treasury rates hover between 2.5 and 2.65%. It gives us reason to pause when equities seem to be ignoring clues emanating from bond market.

While we are not discounting that this could be a late stage market breakout, if small caps begin to fail and push down through recent lows the broader market may follow suit. For the time being investment managers are almost paralyzed in their decision making. While not being able to discredit the new highs in large caps managers are concerned by stock valuations, a lack of volatility and lack of confirmation of recent S&P 500 highs from small cap stocks.

BOY SCOUTS

The Federal Open Market Committee (FOMC) Minutes from the April 29-30 2014 meeting were released last month and the committee noted that a couple of participants felt that conditions in the leveraged loan market had become stretched. We were early into leveraged loans the past couple of years and that served us well. Some clients will now see a reduction in that area in the coming months as we wish to back away from any repercussions associated with a possible bubble in leveraged and covenant lite loans.

While officials and bankers are prepping the investing climate for volatility we continue to prepare our portfolios accordingly. While we do not know if the stock market is in a late stage breakout or breakdownwhat we can say, is that a major market top is likely to be preceded first by increasing volatility, or expanded trading ranges. We feel that battening down the hatches as we approach what is seasonally the weakest part of the market cycle is a prudent idea. Battening down the hatches would see us continuing to invest in less beta sensitive parts of the market including utilities and telecommunications while also maintaining exposure to inflation sensitive issues such as precious metals and oil in case inflation raises its head. We intend to be prepared for any and all outcomes as we are your contingency planner.

 

Blackthorn is an investment adviser registered in the state of Georgia. Blackthorn is primarily engaged in providing discretionary investment advisory services for high net worth individuals.

 All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. All investments involve risk including the loss of principal. This transmission is confidential and may not be redistributed without the express written consent of Blackthorn Asset Management LLC and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential offering memorandum. 

Inflation and Volatility Making a Comeback?

We have been saying for the past couple of weeks that volatility has been nonexistent and is due for a comeback. By way of none other than Lloyd Blankfein, CEO of Goldman Sachs, here is his take on the lack of volatility.

While stock market volatility has dropped to a seven-year low as major indexes continuously rise to record highs, that blissful investing state can’t last forever, says Goldman Sachs CEO Lloyd Blankfein.

The luxury of a steady, calm, quiet market” might continue for a period, but will ultimately halt, Blankfein told CNBC

“At the end of the day, it’s not a normal condition to have interest rates at zero,” he said. “Eventually people will acknowledge higher [economic] growth. Money as a commodity will start to cost something again. . . . That in itself will produce a shock to the market.”

The danger constantly lurks of “some exogenous event . . . that’s going to cause people to have to reset their portfolios,” Blankfein noted.

“There is always something coming that we don’t know about because nobody know what is the future is,” he added.

How long and how low has volatility been? The folks over at Bespoke Investments were kind enough to share this research for us.

 

In fact, it has been two months (42 trading days) now since the S&P 500 last had a move up or down of 1% or more.  To put that in perspective, you have to go back nearly 20 years to 1995 to find a period where the S&P 500 went longer without a move of that magnitude.

 Since 1928, there have been 30 other streaks that lasted longer than 40 trading days.  While extended streaks have been rare in the last twenty years, it hasn’t always been that way.  For example, from the early 1950s through the early 1970s, there were numerous periods of extended calm in the market.  In fact, the years 1963, 1964, and 1965 each saw streaks of more than 100 trading days without a 1% move (the 1965 streak ended in February 1966).  –Tuesday June 17, 2014

 http://www.bespokeinvest.com/thinkbig/2014/6/17/1-moves.html

The inflation trade is making its way back in the aftermath of the Federal Open Market Committee meeting this week. In Janet Yellen’s press conference traders got the feeling that the FOMC is a bit too complacent when it comes to recent inflation statistics which seem to be heating up. Traders bid up the inflation trade across asset classes as gold/silver rallied and Treasury yields rose while the yield curve steepened. Is inflation back? It would change the game a bit. Keep an eye on gold.

Gold bounced off of its lows very aggressively this week in the aftermath of the FOMC meeting. We may now be looking at the top end of that range to see if that can repel the gold bulls. $1400 is going to be a key number. Can it break out of its recent range? A break through $1400 on the upside would ignite a new round of short covering and perhaps foretell a move back into inflation trade winners. US 10 year Treasury yields are also up against resistance and at key levels.  Keep a close eye on gold and the 10 Year US Treasury. A move back towards the inflation could be a game changer.

Speaking of inflation. During the financial crisis we have looked to England as the Canary in the Coalmine. England has a much smaller economy and the Bank of England chose many of the same tricks that the FOMC has used here in the US. The difference may be the impact that the BOE had on their much smaller economy. It is akin to turning a speedboat around rather than a battleship.

In the BOE governor’s annual address to bankers in the heart of London’s financial district, Mr. Carney said that rapid growth and tumbling joblessness mean that the time to begin raising interest rates is drawing nearer.

“There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect,” Mr. Carney said, according to a text of his remarks. -6/12/2014 WSJ Jason Douglas

Treasuries and Gold continue to be our risk temperature gauge. Watch the yield on the 10 Year US Treasury and keep an eye on gold. We could be in for an equity melt up here as investors are caught with too much cash. While the FOMC continues to play the music investors are forced to dance.

In Blankfein’s interview on CNBC I thought that he nailed the description of investing and being in the investing business. Build scenarios and invest accordingly.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

 

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

 

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Fed Concerns and Market Melt Up

The last two weeks we have pointed to the preponderance of Federal Reserve officials out and about warning about complacency from investors and the lack of volatility in the marketplace. Even bankers from Goldman Sachs, Citigroup and JPMorgan have complained that the lack of volatility is hurting their business. Jon Hilsenrath is considered to be a mouthpiece for the Federal Reserve and is charged with helping get the committees thoughts and perceptions into the mainstream. Here is what Hilsenrath had to say in a piece this week in the Wall Street Journal.

Federal Reserve officials, looking out at mostly calm financial markets, are starting to wonder whether tranquility itself is something to worry about.

Other measures of risk aversion and market volatility show an especially striking sense of investor calm. The VIX, which tracks expected stock-market fluctuations based on options trading, has gone 74 straight weeks below its long-run average—a run of steadiness not seen since 2006 and 2007.

Moreover, the extra return that bond investors demand on investment-grade corporate debt over low-risk Treasury bonds, at one percentage point, hasn’t been this low since July 2007. The lower this “spread,” the less risk-averse are bond investors.

The worry at the Fed is that when investors become unafraid of risk, they start taking more of it, which could lead to trouble down the road.

 This indicates a great deal of complacency, Richard Fisher, president of the Federal Reserve Bank of Dallas, said in an interview. When you get complacency you’re bound to be surprised at some point.

Fed Officials Growing Wary of Market Complacency WSJ 6/3/14 Hilsenrath

http://online.wsj.com/articles/fed-officials-growing-wary-of-market-complacency-1401822324?KEYWORDS=hilsenrath

Louise Yamada is the Queen of Technical Analysis on Wall Street. She had some thoughts this week on the overall market and gold. We put more stock into her thoughts on gold as gold cannot really be analyzed based on its fundamentals. It has none. Gold is usually traded based on its technical’s. Here is what she had to say on CNBC.

Judging by the market’s short-term trading pattern alone, famous technical analyst Louise Yamada says that the S&P 500 is on its way up to 2,000. Meanwhile, she sees the Dow Jones Industrial Average heading to 17,200.

With the breakouts that are in place for these indices, I think you could move a little higher, Yamada said on Tuesday’s “Futures Now. You may not see something more contractual until into the fall.

In the three-month chart of the S&P, Yamada observes a “continuation” pattern that indicated the S&P’s upward momentum will continue.

The one concern on Yamada’s horizon is the underperformance of the Nasdaq Composite and the Russell 2000.

There’s a little bit of a glitch in the sense that you have a dichotomy in the market. The Russell 2000 and the Nasdaq look a little bit more precarious…When you start to see part of the markets separate from the leaders that generally means that under the surface you’re seeing some deterioration. But that’s not to say that you can’t get some improvement here.  CNBC 6/3/14

Gold’s outlook is not nearly as bright according to Yamada.

Unfortunately, at this time, All the momentum indicators — daily, weekly and monthly, which is the most structural — are looking very negative.

What makes this so troubling is that gold is getting close to a critical level.

Eyeing gold’s trading range between about $1,400 and $1,200, Yamada says that if $1,200 can’t hold, we might flip even to $1,100, and that would actually break the 2005 trend for gold.

Treasuries and Gold continue to be our risk temperature gauge. Watch the yield on the 10 Year US Treasury and keep an eye on gold. We could be in for an equity melt up here as investors are caught with too much cash. While the FOMC continues to play the music investors are forced to dance.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

And They Danced

Most of the major banks have been out and about in the last week with mea culpas on earnings as Citi JPMorgan and GS are all complaining that low volatility is hurting profits. Who needs bankers and traders when there is no movement in the market? It appears that the Federal Reserve’s monetary policy has dampened volatility and bankers are asking for it back. Building on what Bill Dudley FRBNY President said last week that the Fed is prepared for more volatility in the markets. Volatility is coming. The bankers are asking for it and the Fed is ready to let it happen. Be ready.

Laszlo Birinyi was out and about this week making market calls. Birinyi has an amazing track record and is considered the consummate bull. All bullish all the time. He expressed this week that the bull market may be its last phase – the exuberance phase.

The market is not cheap but it is not especially expensive either,” he wrote Tuesday to clients of his Westport, Conn.-based investment management and research firm. Mr. Birinyi, a long-time bull, was among a select group of Wall Streeters who called the bottom in stocks in March 2009 and has remained optimistic ever since.

But his latest price target is far from exuberant. The S&P 500 at 1970 would mark another 3.1% gain from current levels and an overall 6.6% gain for the year. WSJ 5/27/2014

http://blogs.wsj.com/moneybeat/2014/05/27/laszlo-birinyi-sp-500-to-1970-this-year/

For those so inclined here is a more granular analysis on the market internals from FBN’s very astute JC O’Hara.

Perceived Discrepancies with New Highs

 The market once again made a new high. This continues to be a market you cannot bet against. There are many perceived discrepancies between what one would expect to find at new highs vs. what we currently have. Small Caps are lagging, yields continue to decline, new highs are scarce, and the average stock is still -11% from making a new 52 week high. Combine that with depressed readings from the VIX, credit spreads, and other market stress indicators and you have managers that are paralyzed in their decision-making processes. Many market forces and technical studies are giving contradictory signals. At the end of the day we cannot discredit the markets new high.

 Sure, this may be a late stage market breakout, and according to the masses, a pullback is ‘needed’, but money continues to find its way into stocks. Someone likes the market so much they are willing to add exposure at all-time highs. We want to highlight that this is not just a US market rally, but a global developed market rally. The MSCI Developed Market Index just surpassed its 2007 highs. New Highs have the power to quickly change sentiment. We are at multiyear high levels of neutral readings according to AAII. According to NAAIM, the average manager is under exposed to where we would expect them to be positioned at new highs. This creates a market chase scenario which is dangerous. While we do not love our dance partner we are still on the dance floor and the music continues to play…

What a week in the Treasury market! Yields looked to be breaking down below 2.4% on the 10 year with 2.36% as important support. The bond market seemed to be saying that deflation and not inflation was the risk as the economy appeared to be slowing. Equities would have none of that as they rallied through resistance. Who is right? The bond market or the stock market? What makes sense to us is that the economy may be slowing which is benefiting bonds and bond bears are chasing prices higher and moving yields lower. The equity market on the other hand is still feeding at the Federal Reserve trough. As long as the Fed is still injecting money, its current pace is $45billion a month, stocks will continue to ascend. Its slowing of asset purchases has only slowed the ascent of the market. It will be interesting to see what happens when it does stop its purchases. Gold failed at the $1300 level miserably. Intellectually that also lands in the bond camp of a slowing economy and less than normal inflation. Treasuries and Gold continue to be our risk temperature gauge. Watch the yield on the 10 Year US Treasury and keep an eye on gold. We could be in for an equity melt up here as investors are caught with too much cash. While the FOMC continues to play the music investors are forced to dance.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

 

Volatility and Goldilocks

The Federal Open Market Committee (FOMC) Minutes from the April 29-30 2014 meeting were released this week. While there was not much in the way of surprises in the minutes there were two items that caught our eye. The first was that the committee noted that a couple of participants felt that conditions in the leveraged loan market had become stretched. We were early on into leveraged loans the past couple of years and that has served us well. Some clients will now see a reduction in that area in the coming months as we wish to back away from any repercussions associated with a bubble in leveraged and covenant lite loans.

The second item that caught our eye was the committee’s reference to declining credit spreads which imply an increase in investors’ appetite for risk. The committee also noted that the low level of expected volatility is also implying an increase in investors risk appetite.

While the Technicals of the broader market and the S&P 500 do not indicate any imminent failure small cap stocks continue to maintain their divergence from their large cap brethren. Market participants seem be plowing money into large caps and “safer” stocks while small caps are abandoned. What we may be seeing here is that institutional investors are forced to invest client’s money and are placing that money into safer assets like large cap stocks while a stealth bear market takes place underneath in small caps and biotech. When confusion reigns we turn our eyes to the bond market. The bond market is not playing along with a new high in equities (S&P 500 and Dow Jones) and is indicating a move lower in stocks. It gives us reason to pause when equities seem to be ignoring clues emanating from bond market.

Bill Dudley, the President of the Federal Reserve Board of NY, is a very influential member of the FOMC. When he speaks we listen intently. In a speech this week Dudley noted that he expects rates to stay lower long and well below the historical average of 4.25%. In private meetings Ben Bernanke former Chairman of the FOMC reportedly has stated much the same and that he does not expect rates to normalize in his lifetime. Strong words.

Last week we noted that the summer may be bumpy we think that any retreat by stocks will be backstopped at some point by the Federal Reserve. This week NY Fed President Dudley volunteered that the Fed will be more aggressive in raising rates if markets allow and less aggressive if they do not. The market is calling the tune and the Fed will apply the brakes or the gas depending on the market’s reaction to Fed policy. We think that the Fed will allow some volatility but not just too much. It’s Goldilocks monetary policy. Look for trading bands to widen over the coming months. The last three months have been some of the least volatile since 2006.

The Bank of England is considering whether to raise rates. What happens in England is a precursor to what happens here in the US. Keep an eye on the Bank of England. Treasuries and Gold continue to be our risk temperature gauge. Watch the yield on the 10 Year US Treasury at the 2.5% level and $1300 on gold.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Who Could Have Seen This Coming?

Much is being made of the move in Treasuries this week. Quite frankly we are surprised that seemingly every TV pundit is saying that no one could have seen this coming. That is simply not true. The Citigroup Foreign Exchange department certainly saw this coming as did a host of others. The thesis has been out there for months that when QE came to end we would see lower interest rates and lower stock prices and is part of what convinced us to add duration back in January. Here is what we had to say in our Quarterly Letter at the beginning of the year.

Citigroup Foreign Exchange Technicals group has done extensive research that shows, counter intuitively, that Quantitative Easing leads to higher rates during QE and that the end of QE brings lower rates on the US Treasury 10 year. Citi’s thesis is that more QE leads to a rush into higher risk assets and the dumping of bonds to the government as the buyer. The end of QE brings money back into safer assets like the US 10 year as it flows out of stocks and hot money destinations like emerging markets. 1/18/14 Blackthorn Quarterly Letter

David Tepper, founder of Appaloosa Management, made waves at the SALT conference in Las Vegas this week. Tepper, who pulled in a cool $3.5 billion in compensation last year shocked the investors by stating that this is now a “dangerous market”, “don’t be too fricking long” and that now is a “time to preserve money”, “have cash”. Tepper is a nervous long and has pulled back his exposure in the market. Why is this a big deal? It was Tepper who one of the more voracious bulls on the street alluding to what he called the “Bernanke Put”. This was the concept that as long as the Federal Reserve was putting capital into the markets, prices would only go higher. He pressed his bets throughout. Now the sudden nervousness. Markets got nervous too.

“I think we’re OK,” he said of the current investing climate, “but listen, there’s times to make money and there’s times not to lose money. This is probably (a time when) you’re supposed to think about preserving some of your money. If you’re 120 percent invested, it’s probably too much. You can still be long, but you probably should have some cash.”

Chief among Tepper’s concerns is a deflationary environment and a European Central Bank (ECB) that badly needs to ease monetary policy.

“The ECB—they better ease in June,” Tepper said. “I don’t know how far behind the curve, but I think they’re really, really far behind the curve.”

Should be an interesting summer.

Bonds are helping as we added duration. Stocks are dragging. While the summer may be bumpy we think that any retreat by stocks will be backstopped at some point by the Federal Reserve. Volatility this summer and early fall as the Fed eliminates QE could lead to nice gains come spring time as the Presidential Cycle reasserts itself. Patience is a virtue. Charts of the S&P 500, NASDAQ and Dow Jones are all approaching key levels of support. Next week may be critical.  Treasuries and Gold continue to be our risk temperature gauge. Keep an eye on the 10 Year US Treasury at the 2.5% level and the 50 day moving average on the S&P 500. Have some cash on the sidelines as Tepper suggested.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Summer Heat?

The end of Q1 always brings out interesting insights from around the investing landscape. Quarterly Letters and the Milken Institutes’ Conference give the best and the brightest platforms from which to speak their collective investing minds.

From the Milken Institutes Global conference in Los Angeles comes a voice from the private equity world in the form of Josh Harris who is one of the founders of Apollo Global Management. Harris believes that deals are getting harder and harder to come by and that is due to over exuberant monetary policy from the Federal Reserve. Here is what Mr. Harris had to say.

The quantitative easing and the excess money and the low interest rates have driven pricing up of almost all financial assets to beyond what their intrinsic value might be.

So even though we can all chat about the benevolent growth environment that exists in the U.S. and to a lesser extent globally, the ability to make money and invest wisely on that is very, very challenging right now because you’re starting at a point in the valuation cycle that is very, very aggressive.

Almost every asset is overvalued.

He seems to have company with Daniel Loeb the founder of Third Point and one of the more successful hedge funds managers over the last 18 months.

Early optimism about the U.S. economy may have been “misplaced”, Third Point said on Thursday, adding that key sectors were showing “bubblelicious valuations” and were poised for more volatility in the months ahead.

In a letter to investors obtained by CNBC, the hedge fund said that Federal Reserve Chairman Janet Yellen’s shifting of monetary policy tightening was a contributing factor behind the market’s dour tone.

The correction, however, was “healthy”, said Daniel Loeb, Third Point’s chief, adding that the economy was beginning to accelerate after the punch of a brutal winter and heightening rate hike expectations. As the second quarter cranks up, “it now seems evident that investment performance will require a combination of good stock selection, patience, and deft trading,” he said. -CNBC May 1 2014

Another voice that we always stop and listen to is that of Jeremy Grantham founder of Grantham Mayo and manager of over $100 billion in assets. We spotted an interview of Jeremy Grantham brought to us from the folks over at Fortune. Grantham and his crew over at GMO in Boston have done extensive work on bubbles going back throughout investing history. He is very critical of the policies enacted by the Federal Reserve but goes on to note that most bubbles go to at least two standard deviations above the market’s mean valuations. For those of you scratching your heads trying to remember your college Stats 101 course Grantham feels that a bubble in the overall market would not exist until the S&P 500 hit 2,350 although his models suggest negative returns over the next 7 years based on current valuations.

 Okay, but then I guess that means you think stocks are going higher? I thought I had read your prediction that the market would disappoint investors.

We do think the market is going to go higher because the Fed hasn’t ended its game, and it won’t stop playing until we are in old-fashioned bubble territory and it bursts, which usually happens at two standard deviations from the market’s mean. That would take us to 2,350 on the S&P 500, or roughly 25% from where we are now.

So are you putting your client’s money into the market?

We invest our clients’ money based on our seven-year prediction. And over the next seven years, we think the market will have negative returns. The next bust will be unlike any other, because the Fed and other central banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before. Assets are overpriced generally. They will be cheap again. That’s how we will pay for this. It’s going to be very painful for investors.

In Grantham’s GMO Q1 2014 Letter he goes one to quote the Presidential Cycle which you have heard us refer to from time to time. Grantham and his team note how its effects are seen worldwide and in fact the effect is even greater in the United Kingdom. He calls for more bumps in the road and volatility to increase as the Fed exits from QE. He sees Year 2 of the cycle to be negative but Year 3 is the best year of the cycle and very positive.

Here is the link to the entire letter. A great read if you have the time.

GMO Quarterly Letter Q1 2014

The central theme here is that investors seem to be expecting an increase in volatility as the Federal Reserve tries to exit its loose monetary policy. Even more directly comes another voice telling us to prepare for more volatility while the Fed winds down its purchasing in the open market. This time it comes straight from the FOMC and departing Fed Governor Jeremy Stein.

Jeremy Stein, in one of his last speeches as a Federal Reserve governor, warned that the central bank still may face more bouts of market volatility as it winds down the most aggressive easing in its history.

Some investors may be “underestimating the degree of uncertainty about the future path of policy and are placing levered bets accordingly,” Stein said yesterday in a speech to the Money Marketeers of New York University. “So we may have some further bumps in the road as this all plays out.”

In response to an audience question, Stein said “it’s important that we not get goaded into thinking we’re responsible for minimizing market volatility.” -Bloomberg 5/7/14

A not so subtle shot across the bow if you will. We will take that as a warning that the Fed knows that volatility is coming. Read that last line from Bloomberg again. The Fed knows volatility is coming and it appears that they do not intend to do anything about it.  A 10% correction could easily morph into a 20% correction as the Fed tries desperately to remain on the sidelines in the event of a market retreat.

I think that I have depressed you enough. Remember though that there may be some light at the investing tunnel and no it is not a train. At least we hope. Volatility this summer and early fall as the Fed eliminates QE could lead to nice gains come spring time as the Presidential Cycle reasserts itself. Patience is a virtue. Small Caps continue to tumble and diverge from the broader market which is usually a warning sign. The 10 Year US Treasury keeps flirting with breaking through recent highs. That also could be signifying a weaker market.  Treasuries and Gold continue to be our risk temperature gauge. Keep an eye on Small Caps and the 10 Year US Treasury.

The changing opportunity set over time means you will do well by reducing risk significantly when faced with a less favorable set of expected returns and increasing risk when looking at a particularly favorable set of asset valuations. -Ben Inker GMO Q1 2014

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Tiny Bubbles

The market may not be in a bubble but there have been pockets of such. The Biotech sector, 3D printing stocks and battery power stocks do seem to have “bubble” characteristics. Those bubbles also seem to be bursting. Biotechs which surged at the dawn of 2014 have now given back all of their gains from earlier in 2014. 3D printing stocks are now down 30-40% off of their highs of late 2013 and battery power stocks have recently taken one on the chin. While the market continues to struggle with new highs it is important to try and break down some of the internals of the market in order to see if this rally still has steam. Keep an eye on the bubblier portions of the market along with the performance of small caps vs. large caps and how the most shorted stocks perform against the broader market. A break down in these areas could portend a break down in the broader market and coincidentally make for a healthier market.

Since Janet Yellen’s comments about an earlier than expected rate rise in the US the best performing sectors have been financials and semiconductors while biotech and consumer durables/apparel have been the biggest losers. Surprisingly, utilities and telecom services have hung in there quite well. If we have had a seismic shift in the market post Janet Yellen’s comments we would expect the winners and losers to continue in these same directions. We will be keeping an eye on these sectors especially the financials.

FINRA is investigating the trading of Puerto Rico’s municipal bonds. As you may or may not know Puerto Rico is in sore financial shape. They were however able to access financial markets and float $3.5 B worth of bonds last week. Those bonds were to be sold in denominations of $100,000 or more in order to make sure that institutional buyers or very large investors were involved in the transactions. The authorities wanted to be sure that all investors involved were aware of the possibility of default by Puerto Rico. In the last several days transactions have been made below that threshold indicating the possibility of smaller investors getting into these bonds at par value. Red flags have gone up at FINRA and here at Blackthorn. Just last week I had a client ask me about these bonds as he received a phone call from an investment firm trying to sell him Puerto Rico muni bonds. We are not making an investment call either way on these bonds. We are just making you aware. Caveat emptor.

The market ended the week on a sour note with Friday’s close being a real clunker. Was the selloff from Friday morning’s highs about geopolitical risk or something more? We will find out next week. Charts are looking a bit rough. A break of the 1840 level on the S&P 500 could bring further selling. Will we get saved by end of the quarter window dressing?

US Treasuries had a back up in yield this week as Janet Yellen made comments about earlier than expected rate rises here in the US. Gold and Treasuries have been the flight to safety trade as Ukraine heated up. Now they took the brunt of the hit as Ukraine cooled off and Yellen promised higher rates sooner. Treasuries and Gold conintue to be our temperature gauge for both for rates and geopolitical risk. Keep an eye on how they act this week.

The Fall and Winter are the best performing seasons for the stock market but April is a standout if we look at monthly performance. Could we be in for one more move higher in the market before the summer doldrums kick in? Summer is statistically the worst season for gains in the stocks market. (Hat tip to Bespoke Investment Group.) http://www.bespokeinvest.com/

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on March 23, 2014 at 10:48 am  Leave a Comment  
Tags: , , , , , , , , ,
Follow

Get every new post delivered to your Inbox.

Join 126 other followers