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: , , , , , , , , ,

All Eyes On Ukraine

The Ukrainian situation seems to have changed some of the underpinnings and hallmarks of the recent rally in the market. If one were to look at the internals of the market rally one would see that small caps and biotech have been leaders in the market and there has recently been talk of a bubble having formed in biotech. The biotech sector began to give back some of its gains this week and small caps began to lag the market. Another hallmark of the rally has been the pain inflicted on short sellers. One strategy that has been successful for investors has been to be long the most shorted names. They would fall the least in down moves and rallied the most when markets reversed course. That was not the case last week. The following is courtesy of Bespoke Investment Group.

After the last couple of days of market weakness, the most heavily shorted stocks have gone from leading the market to lagging.  Through this morning, the average return of these stocks during the month of March is a decline of 1.41% compared to a drop of just 0.55% for the S&P 1500 as a whole.  

It will be interesting to see how long this underperformance of the most heavily shorted stocks lasts.  Prior periods where this has been the case have proven to be brief, so if it lasts for an extended period of time, the market’s recent weakness may prove to be a little more long-lasting.

http://www.bespokeinvest.com/thinkbig/2014/3/14/shorts-catching-a-break.html

More smart money is selling as we pointed out last week that insiders at investment firms Carlyle and Oaktree were selling large amounts of stock. This week had publicly traded hedge fund manager Fortress insiders selling stock as well.

In a recent report from Mark Hulbert at Market Watch comes insight on corporate insider actions in the US.  According to Hulbert, corporate insiders are more bearish than they have been since at least 1990. Hulbert’s analysis leads him to believe that corporate insiders are selling at pace more than double the average since 1990.

 http://www.marketwatch.com/story/in-the-know-insiders-are-dumping-stocks-2014-03-14

Finally our attention turns to Seth Klarman founder of the Baupost Group and one of the more successful money managers out there. In Klarman’s recent investor letter he noted that “most” investors are downplaying risk noting that most people are not prepared for anything bad to happen. “No one can know what the future holds, but any year in which the S&P 500 jumps 32% and the NASDAQ Composite 40% while corporate earnings barely increase should be cause for concern, not further exuberance,” .

“Our assessment is that the Fed’s continuing stimulus and suppression of volatility has triggered a resurgence of speculative froth,” while citing numerous examples of overvalued internet stocks that defied value investing logic.

Comparing the economy and the Federal Reserve’s management of it to the movie The Truman Show, where the lead character lived in a false, highly-orchestrated environment, Seth Klarman notes with insight, “Every Truman under Bernanke’s dome knows the environment is phony. But the zeitgeist is so damn pleasant, the days so resplendent, the mood so euphoric, the returns so irresistible, that no one wants it to end and no one wants to exit the dome until they’re sure everyone else won’t stay on forever.” (H/t Zero Hedge)

The outcome to the Ukrainian crisis may have an outsized effect on markets in the weeks to come. Investors may just be looking for an excuse to take some profits and exit the dome as the mood becomes less euphoric especially if bullets start to fly. Keep an eye on US Treasuries. They had a whopper of a move last week and are the temperature gauge of geopolitical risk.

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 16, 2014 at 7:37 am  Leave a Comment  
Tags: , , , , , ,

Ghosts of Irrational Exuberance

Dallas Federal Reserve President Richard Fisher was in Mexico City this week and spoke with his usual candor on Fed policy, asset pricing and the ineptitude of our current government. Fisher has an interesting vantage point on our economy and fiscal/monetary policy and his frankness is refreshing. In his speech Fisher warns that the Fed’s bond buying may be distorting markets and that some indicators like price to forward earnings ratios, margin debt and market capitalization to GDP have risen to levels not seen since the dot com boom of the late 1990’s.

I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis. With its massive asset purchases, the Fed is distorting financial markets and creating incentives for managers and market players to take increasing risk, some of which may result in tears. And all this is happening in uncharted territory. We have aided creation of massive excess bank reserves without a clear plan for how to drain them when the time comes. And there is the challenge of doing so while keeping inflation expectations stable.

 We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.’

 http://dallasfed.org/news/speeches/fisher/2014/fs140305.cfm

On the subject of margin debt comes these stats from Jason Goepfert of SentimenTrader by way of Arthur Cashin.

 The latest margin debt figures were released for January showing another uptick in debt and decrease in the net worth of investors. The “available cash” for investors to withdraw is now negative $159 billion, another record low. As a percentage of the market cap equities of all US equities, it amounts to -0.75%, tied with February 2000 for the most extreme figure since June of 1987.

Our attention turned to bonds when it was reported by Bloomberg that Warren Buffett has taken his bond holdings down to their lowest level in over a decade. Buffett, never one to hold an overweight in bonds has lowered his bond holdings at his insurance units to just 14%. Buffett typically holds between 20-25% of his insurance units holdings in bonds. As Fisher said in his speech in Mexico City this week, all asset valuations are getting distorted. The only question is which is least overvalued or do you hold significant amounts of cash earning very little or nothing. Buffett’s cash position has risen to almost 26% of the assets at his insurance units. Buffett is overweight cash, earning very little, and he is not happy about it either.

http://www.bloomberg.com/news/2014-03-06/buffett-cuts-bond-allocation-as-berkshire-warns-on-yields.html

Insiders at some of the largest and most successful money management firms are moving money to the sidelines in their personal accounts. Executives at Carlyle and Oaktree sold $250MM and $300MM respectively of their personal holdings. Follow the smart money.

 It seems reasonable to be prudent here as the bull that started in March of 2009 is now 5 years old. This bull is now the 6th longest on record and the 4th best performing. Could we be in a bubble like that of 1997-1999? It is possible with the Fed still pouring money in. My philosophy here is to keep our hands in the game, find the cleanest dirty shirt and keep your options open if things begin to turn south. Cash pays nothing but we feel that we are in good company with Buffett as he is also underweight bonds and overweight cash.

 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.

Sage Advice on Investing

 Howard Marks was interviewed by a Swiss publication titled Swiss Finanz und Wirtschaft late last week. Here are some great tidbits that caught our eye from a Master of Investing on the role of emotions.

 I’ve been in this business for over forty-five years now, so I’ve had a lot of experience.  In addition, I am not a very emotional person. In fact, almost all the great investors I know are unemotional. If you’re emotional then you’ll buy at the top when everybody is euphoric and prices are high. Also, you’ll sell at the bottom when everybody is depressed and prices are low. You’ll be like everybody else and you will always do the wrong thing at the extremes. Therefore, unemotionalism is one of the most important criteria for being a successful investor. And if you can’t be unemotional you should not invest your own money, period. Most great investors practice something called contrarianism. It consists of doing the right thing at the extremes which is the contrary of what everybody else is doing. So unemotionalism is one of the basic requirements for contrarianism.

There are two main things to watch: valuation and behavior. A great thing about investing is that you have historic valuation standards. You should be aware of them, but you shouldn’t be a slave to them.  You can compare the current P/E ratio to historic standards and see that the current P/E ratio is about fair relative to history. So valuations are moderate to a little expensive in most areas. Looking at investor behavior, you can ask yourself: Is everybody at the club, on the train or in the office talking about stocks? Is everybody having fun and making easy money? Is everybody saying even though the market has doubled, I’m going to put more money in? Is every deal sold out? Is every fund sold out? In other words: Is the party rolling? And if that’s the case, then you should be very cautious. It’s like Warren Buffett says in one of my favorite quotes: The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.

 It must be that time of the year as investing masters are out and about giving sage advice. Warren Buffett gave a preview of his Annual Letter this week to his good friend Carol Loomis at Fortune magazine and he also warns about the effect of emotions on investing. Here is an excerpt.

In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.

 I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/

The bulls are still in control although there does seem to be some doubt due to their failure to launch. Friday’s action had the bulls squarely in charge even in light of poor economic numbers. The bulls had the market plus 150 before reports came in that Russia had invaded the Ukraine sending stocks careening to their lows of the day and negative on the session. The market rebounded to up 40 points on the Dow but I would have to say it was not a real confidence builder for the bulls. The bull’s advances, having been repelled 4 times at the old high and now punching through only to rapidly fall back leaves us in doubt about the bull’s ability to maintain the new high. Keep an eye on the new high. Let’s see if the bulls can maintain their ground. Bonds continue to perform well as QE is wound down.

 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.

Farther, Higher (Lower?), Faster

The important thing in life is not the triumph but the struggle, the essential thing is not to have conquered but to have fought well. – Pierre de Coubertin -Founder of the Modern Olympics

 I have always been drawn to the Olympic ideals and the value that they place on excellence, friendship and respect.  It is these values that have a place in the promotion of peace played by the Olympics and the ancient tradition of respecting a truce while the Olympics were played. While the Olympics are drawing to a close it is back to reality for politics as the Ukraine erupts and for markets as another option expiration week ends.

This week in the equity markets saw more of the bounce back from the selloff that started in late January. We expected as much and now we have approached the old high.  The real test comes next week. The market has rallied back to its old high but this is where the street may begin to question the rally’s validity. If the rally cannot break through the old high it may be in danger of falling and retesting the lows around 1740 on the S&P500. Conversely, a breakout above the old high next week could bring more money in as investors feel that they missed another dip and that this market may never go down again. A breach of either of these levels could bring swift resolution to the question of whether or not 2014 will bring more volatility for equity prices.

Not only are Federal Reserve officials pushing to be transparent about the ending of QE one of our close allies is out trying to back up the Federal Reserve. Ripples felt in emerging markets from the tapering of QE here in the United States have caused a stir of late and we are getting some backup from our friends Down Under. Here is some insight by way of Arthur Cashin and his friends at the Lindsey Group. (Emphasis mine.)

 The Australian Treasurer Joe Hockey also had some comments about the Fed tapering, its impact on the global economy and how to deal with it. He said “It’s not something that hasn’t been foreshadowed…The world can no longer rely on methadone every day. Sooner or later we need to wean ourselves off and that’s what tapering is about…Our own central banks have the responsibility to act in our national interests. It’s a balancing act. The US Fed can speak for itself, but I don’t see any systemic difficulties in developing markets.”. Cashin 2/13/14 Peter Boockvar Lindsey Group

 It looks like the Tapering of QE is here to stay for the time being. Officials around the world are telling you to get used to the US backing away from QE.

Are markets expensive? The question is continually asked by investors. Here is one clue. Three very large M&A deals have been announced in recent days. Comcast is buying Time Warner Cable for $45B in an ALL stock deal.  Actavis is acquiring Forest Labs for $25B of which 2/3rds will be paid in stock. The third deal has Facebook buying privately held Whatsapp for $19B of which 75% of that purchase price is also in stock. That tells you what the acquiring company’s execs think about their own stock. It is certainly not cheap. If a business uses stock instead of cash to make a deal it tells you that the stock is expensive and that cash is coveted. Here are three companies that obviously feel that their stock is a good currency to trade to gain value.

It looks like the Tapering of liquidity is here to stay and so is volatility. Any hopes that the Fed might be swayed by other central banks, emerging market tremors or stock market volatility can be put to bed. 2014 is off to a rocky start and that will probably continue.

We did get our oversold bounce although it may have gone a bit further than we expected. The key to continued market performance may lie in how equities perform next week. The support and resistance levels of 1740 and 1850 on the S&P 500 must be watched. Net week should go a long way as to telling us who is in control – the Bulls or the Bears.

 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.

Two Hawks?

Eyes around the world have turned to the Federal Reserve as their exit from Quantitative Easing (QE) has shaken markets. Each Fed member while able to espouse their own opinion is still part of a larger group at work. That is why when we listen to Fed members speak we also look to see the message of the group at large. For instance, when a member noted for their hawkish or dovish tones speaks it is usually offset by a speaker from the opposite camp in following days. We would point out that we heard two speakers this week. One hawk and one dove. The hawk came first by way of Richard Fisher of the Dallas Federal Reserve. Fisher is not backing down from his stance that QE must be wound down. Here is what he had to say by way of Arthur Cashin early this week.

 No Tapering The Tapering? – Dallas Fed President, Richard Fisher, was interviewed by Fox after the NYSE closed.  Here’s what MarketWatch heard:

 Fed’s Fisher sees no reason to slow bond taper

 WASHINGTON (MarketWatch) - Dallas Federal Reserve President Richard Fisher said he thinks the central bank should continue to reduce bond purchases despite falling U.S. stock prices and currency turmoil in overseas economies. In an interview on Fox Business, Fisher on Monday said the Federal Reserve is focused on how the “real” economy is doing and not just the stock market. So long as the economy shows progress, he said, the Fed should cut bond purchases from the current rate of $65 billion a month. Fisher pointed out that stock prices are still sharply higher compared to one year ago and he noted that markets are occasionally prone to sharp gyrations regardless of the health of the economy. Fisher is a voting member this year of the Fed’s policy-setting committee.

 His comments were to be offset by noted dove Chicago Federal Reserve president Charles Evans. Evans chose to emphasize that inflation was low and policy would remain accommodative for some time. He went on to say that inflation and not unemployment was the new bogey. Interestingly, he backed Fisher on the continued tapering of QE.

DETROIT–Chicago Federal Reserve President Charles Evans said Tuesday he is concerned inflation is still below the central bank’s 2% target.

The Fed has indicated it will maintain low rates until unemployment reaches 6.5%, but Mr. Evans said the inflation rate will be a factor in the central bank’s decision on when to raise the federal funds rate. The federal funds rate will stay at zero into 2015, he said.

“As long as inflation is below our 2% objective we can continue to have highly accommodative policy,” Mr. Evans told reporters following a speech to the Detroit Economic Club. “The inflation data is going to continue to be a puzzle.”

Mr. Evans said he sees no evidence of pressure to raise wages. Businesses “are getting by with who they’ve got right now.”

He also defended the pace of the Fed’s tapering of its asset purchases, and said it would be a “high hurdle” to change the $10 billion-a-month reductions over the next several months.

“It’s the right time and approach to moderately reduce our asset purchase pace,” Mr. Evans said.

Noting the recent upheaval in some emerging markets, he said that the Fed made clear in advance that it would be unwinding its quantitative easing, and that this shouldn’t have been “a big surprise” to investors. - WSJ 2/4/14

If that wasn’t enough it seems as though the authorities in China are ending the liquidity game and taking their ball home too. From Bloomberg comes an article this week that outlines China’s issues with shadow banking and liquidity fueled growth there. In an effort to get things under control and prevent a rapid melt down China is willing to withstand further volatility.

China’s central bank said reasonable volatility in money-market interest rates must be tolerated as it manages liquidity in the country’s financial system to rein in credit growth.

China’s benchmark repurchase rate surged to a record in June after the central bank refrained from addressing a cash crunch in the interbank market as it cracked down on shadow finance. The PBOC said today that while it will use tools including the reserve-requirement ratio and short-term lending facilities to ensure “appropriate liquidity,” it won’t bankroll a growth model that relies on investment and debt. – Bloomberg

It looks like the Tapering of liquidity is here to stay and so is volatility. Any hopes that the Fed might be swayed by other central banks, emerging market tremors or stock market volatility can be put to bed. 2014 is off to a rocky start and that will probably continue.

 Well, we did not get our Game Set MATCH as per Tom DeMark as the week ended higher. It’s back to the drawing board for Tom. We did get our oversold bounce although it did look in doubt Wednesday as the bulls seemed quite timid. More volatility to come as Central Banks have green lighted volatility in order to get liquidity back under control.

 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.

Game Set Match?

 As you know we always watch and listen to what Richard Fisher of the Dallas Federal Reserve has to say as he speaks broadly and clearly on Fed policy. He had this to say yesterday.

 Richard Fisher, president of the Federal Reserve Bank of Dallas, said Friday that he’d like to see the central bank’s bond buying fall to zero “as soon as practicable,” which could be by the end of the year if economic conditions allow.

As a new voting member of the Fed’s policy-setting committee, he voted earlier this week to reduce the monthly bond buying by $10 billion to $65 billion. The hawkish and outspoken Fisher has argued since last spring to start reducing the stimulus, saying it had lost its effectiveness.

 If you believe what Fisher has to say then the Tapering of QE is here to stay and so may the downdraft in equity prices The Fed reduced their purchases by an additional $10B a month this week bringing the number down to $65B. Their reduced purchase have caused waves in Emerging Markets around the world but a slow and steady pace may be just the ticket. Markets have seen selling but it has not been the out of control variety.

By way of Arthur Cashin comes some insight on the selloff from Tom DeMark. DeMark is a noted technical analyst or as some would say a “witch doctor” who studies market charts for a living. Well, DeMark has made quite a living out of it. He is paid to wield his craft by some of the largest and most successful hedge funds and investors around. Here is what he had to say this week on the most recent sell off. 

“Yesterdays up close …a close below 1767.20 on the S&P cash and 1762.00 on the future and it’s GAME SET MATCH…DeMark  “…1929 style crash” ? I have no idea but for now ref close confirmation targets S&P 500 cash 1762 and 1725.02…sell”

 Game. Sat. Match. Scary stuff from a Wall Street legend. We don’t think so but will keep DeMarks’ thoughts in mind as we go about our business next week. We recently bought some longer term US Treasuries and that has helped returns the past two weeks and would be just the ticket if it is indeed game, set, match. The most recent close on the S&P 500 was 1782.

This week saw continued pressure in emerging markets due to further tapering of QE. Turkey’s central bank attempted to assuage fears by raising interest rates 475.  As Warren Buffett says when the tide goes out you find out who has been swimming naked. It appears that Turkey  may have been. The market suffered again this Friday because of potential currency devaluations over the weekend in emerging countries. Governments make such moves typically over a weekend as banks are closed. We think that next week could find some support for markets as they are now in an oversold position. New pension fund money coming into the market at the beginning of the month may help the S&P 500 find support at 1770. Turnaround Tuesday may be back next week as we look for an oversold bounce.

A selloff of some magnitude would make the market cheaper on valuations than it has been in years with US corporate balance sheets been made much healthier since the financial crisis. The question remains, will the FOMC have the courage to continue to taper in the face of investor consternation and Emerging Market volatility? The market has not seen a selloff of 20%+ in over 2 years. A selloff would be cleansing and bring a healthy dose of fear (and bargains) back into markets.

 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.

Beer Goggles and Down January’s

On the 14th of this month Dallas Federal Reserve Governor Richard Fisher made a speech titled Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes. We love reading what Mr. Fisher has to say on monetary policy because he is not an academic and is one of the few, and perhaps only, member of the FOMC to have real world investing experience. You will find the link to his full speech below. It is well worth the read.

Fisher notes that markets have a way of overshooting at times and correcting. This may or may not affect the economy. It is his (and my) hope that it will not. In fact we will go on to outline how this retrenchment in the stock market may actually help the economy. Here is more from Fisher below and how he plans to use his vote on the FOMC this year.

…markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations.

This need not threaten the real economy. The “slow correction” of 1962 comes to mind as an example: A stock market correction took place, and yet the economy continued to fare well.

“…QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good…”

Here is the point as to the market’s beer goggles. Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.

http://www.dallasfed.org/news/speeches/fisher/2014/fs140114.cfm

 How could this move lower in the market actually help the economy? Think of it this way. US corporations are forced to manage earnings higher in a rising stock market according to Wall Street’s expectations. After all we, as an investing community, have screamed for years that executive pay should be tied to performance. What better performance to attach it to than corporate stock performance? US corporations are borrowing to buy huge amounts of their own stock back thereby raising earnings per share. Earnings have been rising but revenues have not kept pace. If stock prices begin to fall executives may feel less pressure to manage to Wall Street’s expectations and may begin investing more in the business side of things thereby helping the economy and begin to expand business, increase employment and focus on raising revenue.

This week saw pressure in emerging markets due to weakness in China and further tapering of QE. As Warren Buffett says when the tide goes out you find out who has been swimming naked. It appears that Turkey and Argentina may have been. The market suffered on Friday because of this. Friday’s are typically a day when traders wrap up positions, cover shorts and typically have an upside bias. Not this week. Turkey, Argentina, and Venezuela are all prospects for a devaluation of their currency. Governments make such moves typically over a weekend as banks are closed. Governments and expectations of government moves are back distorting markets.

The S&P 500 is down 3.14% for January.

January Barometer: As January goes, so goes the year
Does the January Barometer work? Based on S&P 500 data going back to 1928, January is a good predictor of the year. When January is down, the year is up only 42% of the time and the S&P 500 has an average decline of 2.3%. This compares to positive annual returns 66% of the time and an average return of 7.5% for the S&P 500 going back to 1928. - Stephen Suttmeier BofAML

 

Down Januarys Serve as a Warning – According to the Stock Trader’s Almanac, every down January for the S&P 500 since 1950without exception, preceded a new or extended bear market, flat market, or a 10% correction. 12 bear markets began, and ten continued into second years with poor Januarys. When the first month of the year has been down, the rest of the year followed with an average loss of 13.9%. In most years, these declines later provided excellent buying opportunities. - JC PARETS All Star Charts StockTwits

(Note the first research from Stephen Suttmeier is from 1928 until 2013 while JCParets is only since 1950.)
They say that Fed chairmen always tested early on in their terms. Could this be Yellen’s test?

The length of time without a correction in the market has created instability. Risks were poured on as there is now a perception that markets only go up. There is a lack of tolerance for any loss at all in markets. Recently, feedback from trading desks on the Street is that there has been much consternation over any move lower in markets bordering on sheer panic as to finding a reason why the market has moved incrementally lower. A somewhat fragile emotional state. Pull backs and corrections are normal for markets. Investors seem to have lost that concept over the last 2 years. We are due and it is healthy. Remind yourself that a 3% move lower is not the end of the world. We do believe that while the end of the world trade was on the table in 2008 it has been shown by governments that they will not let that happen. Rest assured, governments have the most to lose in that scenario and will change the rules again to make sure that the end of day’s trade does not occur. A selloff of some magnitude would make the market cheaper on valuations than it has been in years with US corporate balance sheets been made much healthier since the financial crisis. The question remains, will the FOMC have the courage to continue to taper in the face of investor consternation and Emerging Market volatility?

 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 January 25, 2014 at 12:37 pm  Leave a Comment  
Tags: , , , , , , , ,

Blackthorn Quarterly Letter

Blackthorn Quarterly Letter 

I learned that courage was not the absence of fear, but the triumph over it. The brave man is not he who does not feel afraid, but he who conquers that fear. – Nelson Mandela

The dawn of any New Year brings the anticipation of what might be and the temptation to make predictions about how things might unfold. While we are not in the crystal ball business we find the turn of the calendar a useful time to analyze the current landscape and perhaps see a bit of what the next year may hold in store. Seminal moments in investing tend to happen around the calendar as we humans are prone to repeating behavior at certain times of the year.

Before we get to the seasonal effects let’s start with what analysts around Wall Street are saying 2014 holds in store. The consensus forecast on the street for 2014 is one of the most bearish forecasts in years. While 2013 may have defined the term “broad based rally “analysts expect the S&P 500 to close higher by only 5.8% by the end of 2014. That is a little more than half the average return predicted by analysts over the last decade.  Analysts are obviously a bit more reluctant about predicting outsized gains after such a stellar year in 2013.

Given the outstanding performance of the S&P 500 in 2013 it makes sense to investigate what has happened in years that followed a plus 20%  year. From Piper Jaffrey comes research that points to another up year for stocks but not without some bumps in the road.

 Since 1945 the S&P 500 has posted 21 annual gains of more than 20 percent. The average gain the next year was 10 percent, with the index up 78 percent of the time. However, every one of those “good” years saw drops of at least 6 percent and up to 19.3 percent.

As you know we look to all sorts of trends to gauge market sentiment. One trend worth noting is the US Presidential Cycle. Thanks, also to Piper Jaffrey, comes an outline of Year 2 of the US Presidential Cycle where we can look for more hints as to what 2014 has in store in this, a mid-term election year.

More particularly, the second year of the cycle—the year when midterm elections are held—tends to be volatile, with substantial pullbacks, corrections or outright bear markets not at all uncommon. The typical return during such years is just 5.3 percent, or barely half the norm.

Piper Jaffrey points out that since 1930, pullbacks during midterm years have averaged 17 percent.

We expect to see more turbulence than we did last year as the Federal Reserve begins to back away from it Quantitative Easing policy. 2014 may also see Washington DC go into hyper dysfunctional mode as the Senate and House are up for grabs. One thing to remember is the fact that it is common to have volatility in the stock market. What is uncommon is to have the market move up in a straight line as it did in 2013 with little or no correction along the way. We expect the market to finish on the plus side again in 2014 but there is certainly room for a pullback along the way as the current bull market is now over 4 years old. The internals of the market have eroded a bit of late as small caps have begun to lag the broader market, margin debt is now striking at highs not seen since 2007 and short interest is hitting lows not seen since that peak in 2007. While history does not repeat we can be fairly certain that it does rhyme given the tendencies for human beings to seek patterns and to respond in a psychologically consistent way.

Late last month the Federal Open Market Committee (FOMC) decided to taper their purchases of US Treasuries and Mortgage Backed Securities by $10 billion. While this may have taken some market participants by surprise it seems that the committee is sensing a diminishing return on their investment in QE and are seeing its impact on economic conditions diminish as well.

 “A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue, although some noted the difficulty inherent in making such an assessment,” FOMC Minutes 12/17-18/2013

There was also concern noted by committee members that one of the consequences of QE was it could be providing incentives for excessive risk taking in financial markets.

In their discussion of potential risks, several participants commented on the rise in forward price-to-earnings ratios for some small cap stocks, the increased level of equity repurchases, or the rise in margin creditOne pointed to the increase in issuance of leveraged loans this year and the apparent decline in the average quality of such loans. – FOMC minutes 12/17-18/2014

This path of tapering and eventually ending of QE has been a bumpy one in years past. In fact, the ending of the last three QE programs has had the impact of actually reducing bond yields and negatively impacting the stock market. How will the tapering and possible end of QE impact markets in 2014? Will the market continue higher given that the Fed is still purchasing assets in the open market or will market participants try to exit the stock market before QE’s end? Since the dawn of the financial crisis we have postulated that the hard work for the Fed would come when it was time to withdraw.

The bond market has been a dangerous place to be in most investor’s minds and to ours as well. Our response to inflated bond prices has been to underweight our allocations to bonds as well as shorten the duration of our portfolios to the 5-7 year range. This was  done in order to account for the risk of rising interest rates. 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.

While we are underweight bonds and have shortened the duration of our bond portfolio in recent years the above analysis may lend to actually lengthening our duration for a time if QE is indeed coming to a close. Another reason that the bond market may find support here comes from a side effect of the equity rally starting in the spring of 2009. The doubling of the stock market from its low in March of 2009 has had the additional benefit of inflating assets held by pension funds. Pension funds are now more funded then they have been in years. Pension fund managers may now begin to decrease their equity allocations and tilt it towards one more heavily weighted in bonds. Pension funds are notoriously conservative in their investing. No pension fund manager, after having lived through the crisis of 2008, will be willing to risk their newly found “fully funded” status. A movement out of equities and into one more heavily weighted in bonds may help forestall giving back those well earned gains and their all important fully funded position.

 Remember, central banks don’t create growth. They only pull demand forward much as they have pulled market returns forward. The Fed has pulled market returns forward by pushing investors into riskier assets. While we are looking for a bumpy 2014 US corporations and banks have buttressed their balance sheets for any storm that may approach whether that storm is due to lessened QE, a Chinese banking crisis, higher interest rates in the US or a backlash from political ineptitude as Congress prepares for midterm elections.

Our companies are the most financially prepared and most productively operated they have been at any time during the nearly four decades since I graduated from business school. –Richard Fisher FOMC Committee Member – 12/9/13.

The key to 2014 may be how the FOMC manages their playbook. The FOMC hopes to engineer a “soft landing” as they try to ease back away from their Quantitative Easing policy and attempt to wind down their balance sheet. We are of the inclination that engineering a soft landing will be extremely difficult and not without some spasms of volatility given the extreme nature of QE. Thus our expectations for 2014 are for increased volatility and single digit returns for both bonds and stocks as QE is withdrawn from the market.

If a selloff in asset prices does occur it will be important to remember that the positive trends in the United States are still in place.  US Corporation’s balance sheets have been fortified, unemployment in the US is shrinking and the idea of energy independence being brought forth by the Shale revolution gives the United States a clear set of advantages when it comes to growth on the world stage. The stock market, overvalued as it is after having doubled from its prior cyclical lows, is still a better bargain today than it was in 2000. Any major sell off from here may turn out to be a great buying opportunity when we look back 10 or 20 years from now.

Going forward we will continue to monitor bond yields, the progress of Quantitative Easing,  the potential mismanagement of the US Congress, Emerging Markets, Europe and China. What happens in those areas will give us clues as to how to react and re-allocate our portfolios accordingly. We wish you a happy, healthy and prosperous New Year and we look forward to seeing and speaking with you in 2014.

 

A healthy respect for uncertainty and focus on probability drives you never to be satisfied with your conclusions. It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference. – Robert Rubin

Published in: on January 18, 2014 at 10:46 am  Leave a Comment  
Tags: , , , , , , ,

Correction Looming??

What say yee in 2014? Thanks to Arthur Cashin and the Trader’s Almanac we can see that the first day of any year is not much of an indicator but the first five days have a very good track record. That is, if the market is higher. The track record of a down start is a bit spottier.

According to the very helpful Trader’s Almanac, the last 40 times the market rose in the first five days, it closed up on the year 34 times (85%).  – Cashin

We were struck by a statement out of the International Monetary Fund (IMF) this week that 1930’s style debt defaults are likely. The following is a good portion of the article which outlines approaches governments may need to take to counteract the large levels of debt. High on their list is inflation.

Many advanced economies are likely to require financial repression, outright debt restructuring, higher inflation and a variety of capital controls, a new research paper commissioned by the International Monetary Fund (IMF) has warned.

The magnitude of today’s debt in Western economies will mean fiscal austerity will not be sufficient, Harvard economists Carmen Reinhart and Kenneth Rogoff said in the report, as policymakers continue to underestimate the depth and duration of the downturn. 

“It is clear that governments should be careful in their assumption that growth alone will be able to end the crisis. Instead, today’s advanced country governments may have to look increasingly to the approaches that have long been associated with emerging markets, and that advanced countries themselves once practiced not so long ago,” they said.

The economists suggest that there are five different outcomes in dealing with this debt and highlight a “prototype” recovery period from their previous research. Economic growth is discounted as being too rare by both economists and austerity packages (as seen in Europe since the financial crash of 2008) are deemed as being insufficient. Instead, the size of the problem suggests that debt restructurings would be needed, they add, particularly in the periphery of Europe. The solution they propose, based on a typical sequence of events in history, shows some combination of capital controls, financial repression (like an opaque tax on savers), inflation, and default.

“In light of the historic public and private debt levels…it is difficult to envision a resolution to the current five-year-old crisis that does not involve a greater role for explicit restructuring,” they said. - CNBC 01/03/2014 Matt Clinch

From an interview in Barron’s this week comes Ned Davis’ opinion on the year ahead. Ned Davis is the head of Davis Research and is very well respected in the street for his take on markets.

However, we’ve looked at all the bear markets since 1956 and found seven associated with an inverted yield curve [in which short-term interest rates are higher than long ones] – a classic sign of Fed tightening.  Those declines lasted well over a year and took the market down 34%, on average.  Several other bear markets took place without an inverted yield curve, and the average loss there was 19% in 143 market days.  We don’t see an inverted yield curve anytime soon.  So, whatever correction we get next year is more likely to be in the 20% range.

Thanks to CNBC and Piper Jaffrey comes a further outline of the US Presidential Cycle where we can look for more hints as to what 2014 has in store. Last blog post we noted the Presidential Cycle. Here are some further tidbits on the cycle and what that means for markets in 2014.

More particularly, the second year of the cycle—the year when midterm elections are held—tends to be volatile, with substantial pullbacks, corrections or outright bear markets not at all uncommon. The typical return during such years is just 5.3 percent, or barely half the norm.

Piper Jaffrey points out that since 1930, pullbacks during midterm years have averaged 17 percent.

“We suspect 2014 may be a good, but not a great year for the broader market (high single-digit to low double-digit return), with a higher level of volatility, and that relative strength-based sector exposure will be key to outperformance.”

Since 1945 the S&P 500 has posted 21 annual gains of more than 20 percent. The average gain the next year was 10 percent, with the index up 78 percent of the time.

However, every one of those “good” years saw drops of at least 6 percent and up to 19.3 percent. Four of those years triggered new bear markets.

So it seems that just about everyone is looking for a bumpy year ahead with a definable correction along the way. On an anecdotal basis we were in a small café in northern Georgia just west of the “middle of nowhere” when we heard two ladies chatting about the stock market. The one woman assured the other woman that there is a correction coming. That confirms it. Exactly everyone expects a correction this year. They could be right but we have learned that the market usually doesn’t work that way. The market has a habit of making a fool out of the most people that it possibly can. Could it be that the correction never comes? It is also possible that the correction is deeper than most expect. Always the contrarian and looking to second level thinking.

Emerging markets have suffered in the first two trading days of the New Year. The Emerging Markets ETF is down 4% in 2014. Thailand’s market is bearing the brunt and Turkey is off to a poor start. 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. Keep an eye on emerging markets like Turkey and Thailand.

The 10 year is looking to bust out over 3%. The holiday may have kept the stock market in line. Seminal changes tend to occur on the calendar. Oil is down 8% over the last 4 trading days and gold is looking to bounce off of lows. Tax loss selling may be responsible for pushing gold to recent lows and bargain hunters look to be jumping in here. We certainly have oil, gold and the 10 year on our radar. We suggest you do the same.

Remember that the turn in the calendar in 2014 may entice managers to raise cash levels early on in the year as to not suffer any outsized losses at the start of 2014. A large loss early in 2014 would make for a tough slog all year. However, missing out on some upside early on in the New Year would be far easier to make up for on the performance side. That could make for a sloppy January. The Fed is back buying in the open market next week so that could help provide some support. They did not participate in the first two days of 2014.

Here is to a happy, healthy and prosperous 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

I learned that courage was not the absence of fear, but the triumph over it. The brave man is not he who does not feel afraid, but he who conquers that fear. – Nelson Mandela

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.

Follow

Get every new post delivered to your Inbox.

Join 126 other followers