Punchbowl

This week our eyes started to focus on bond yields. They had a move higher this week and our favorite bond guru Jeffrey Gundlach noted that he sees 3.25% on the 30 year as the Maginot Line. He feels that if the US 30 Year bond closes above a 3.25% yield for two consecutive days we could be off to the races for bonds and not in a good way. The 30 year closed the week at 3.20%. We are very short in our duration and perhaps getting shorter. A move higher in bond yields would help us as we would be reinvesting our short duration bonds more rapidly into higher yields. As a reminder Gundlach sees bond yields rising to 6% on the 10 year by 2020-2021!! Imagine what that would do to the housing market.

We feel like the market is resolving some issues post Labor Day. Gold seems to be holding here. Emerging markets have found, at least, a temporary bottom. The key question remains will the US Dollar rise or fall? What about equity markets? Equity markets are hitting all time highs and there appears to be a slow, reluctant grind higher. Dow Theory types will say that the recent new high in the Dow Jones confirms the Dow Industrial’s new high. Dow Theorists would then expect 6-9 more months of an upward market. We appeared to be stuck in a range between 2865 and 2915 but the market has broken out higher and there is no real resistance as these are new highs. 2950 and 3000 would be psychological resistance. Emerging markets had a bounce back week as the US Dollar fell. Commodities could be getting legs here if the Dollar continues to fall. If it begins to rise watch the emerging markets.

This market keeps proving its resilience so we can’t fight it. The economy is clicking and Trump tax/repatriation polices are giving it a booster shot. That booster shot is giving the Fed room to tighten more aggressively but policy is still loose. While our Federal Reserve is reducing its balance sheet by $40 million a month global central banks around the world are still injecting $500 million a month collectively into the global financial system. They are slated to take that number to zero early in 2019. Policy is loose but getting tighter. You can almost picture them getting ready to take the punchbowl away.

There are still no signs of a recession on the horizon as the economy is humming right along and that is exactly our concern. We buy when there is blood in the streets. Right now the economy is riding the sugar high of tax cuts and repatriation with accommodative monetary policy. The Fed knows that this is their cover to raise rates. They are tightening policy and lightening up on their balance sheet holdings. There will come a tipping point where monetary and fiscal policies become too tight. If not, then markets and inflation will run. Right now we are riding markets higher but preparing for higher bond yields and higher commodity prices.  Don’t fight the Fed but maybe fade it a bit. We are still in it to win it but looking for places to cut back on risk and adding active management.

 

 

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.

Gradual Squeeze

Local governments are in serious trouble as we are now seeing in Puerto Rico and Connecticut. High taxes, capital flight and pension obligations are going to meet the new order. We see technology and social changes on the horizon that continue to cut out the middle man and the ultimate middle man is government. Driverless cars? No more speeding tickets, DUI’s, parking tickets and lower drug arrests from stopped vehicles. All bring in less revenue for your local and state government. About seven years ago Meredith Whitney offered that muni defaults would begin to rise. She was laughed out of the building.

Ray Dalio is CEO of Bridgewater Associates, one of the largest hedge funds in the world. Ray takes into account not just the numbers as his theories about investing are more all encompassing about where we are in the cycles of debt and the economy while taking into account social and political factors. In his latest blog post on LinkedIn he had this to say on the current environment. We have taken Ray’s thoughts and applied them to muni bond investing. Time to think about a gradual squeeze in muni’s and rising default rates?  https://www.linkedin.com/pulse/big-picture-ray-dalio

At the same time, the longer-term picture is concerning because we have a lot of debt and a lot of non-debt obligations (pensions, healthcare entitlements, social security, etc.) coming due, which will increasingly create a “squeeze”; this squeeze will come gradually, not as a shock, and will hurt those who are now most in distress the hardest.

Central banks’ powers to rectify these problems are more limited than normal, which adds to the downside risks. Central banks’ powers to ease are less than normal because they have limited abilities to lower interest rates from where they are and because increased QE would be less effective than normal with risk premiums where they are. Similarly, effective fiscal policy help is more elusive because of political fragmentation.

Wells Fargo’s unauthorized account scandal is growing. It is now estimated that they created over 3.5 million accounts. If you are still with a traditional broker and not a fiduciary you should ask yourself, “Why?”

Commodities continue to have a rough go of it. Iron ore, copper, and rubber are all well off of their highs with iron ore down 20% and rubber down 30%. The tightening of money in China is having a chilling effect on commodity prices around the globe. West Texas Crude (WTI) rose about 3% on the week but is still under the crucial $50 a barrel mark. Keep an eye on oil for clues about the economy and stock market. The Saudi’s are looking to IPO their precious Saudi Aramco, the largest oil company in the world, and are going to want oil prices higher in order to get more money into their treasury. The Iranians and the Russians may try and pump more oil in order to push prices lower as their interests run counter to the Saudi’s. OPEC meets on May 25^th. Oil has been on a roller coaster in 2017 and we do not think that the second half of the year will be any different.

The market is still stuck in consolidation mode. The S&P 500’s leadership continues to help pull the index higher while the amount of stocks above their 50 day moving average drops from 80% to 50%. Things are getting narrow at the top. This could be another sign that investors should be adding active management back into their portfolio. Stock trends continue as Hong Kong, England, Brazil, Japan, and the US all continue to consolidate gains or head higher. China? Not so much. Hard to argue against the bull thesis as the market continue to hold gains or plow higher. We think a southern neighbor could be the next leading stock market.

We still expect the market to break out of its recent range to the upside and in favor of the bulls. More often than not when a market consolidates a major move it breaks out of that pattern the same way that it came into it. It’s all about momentum and the animal spirits of the market.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

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.

 

The Federal Reserve is Becoming the Problem

 

We have contemplated writing a blog titled “How I learned to Stop Worrying and Love the Fed”. We just cannot get ourselves over that line. The Federal Reserve has created and continues to promulgate a very dangerous position as capital is mal-invested. It also continues to punish a generation of savers, fixed income retirees, insurance companies and pension funds. The zero and even, in the case of Europe and Japan, Negative interest rate environment is hampering all of these groups ability to operate.

In light of this low income environment, we are seeing larger amounts of Ponzi schemes and investment fraud out there. Salesmen are pitching hard on annuities and income oriented schemes. These schemes are being proffered as a way to get 7-8% income on your investments. There is no Golden Ticket. There is no Holy Grail. If you are being promised those levels of income off of your investments it comes with outsized risk. Please do your due diligence. Everyone from insurance companies to pension funds to individual investors are begging for income as central banks have suppressed rates. If someone promises you this run, don’t walk, in the other direction. If it sounds too good to be true, it is.

Annuities are increasingly being offered as a solution but they come with their own set of problems. You may think that you are offloading risk on the annuity provider but it may blow back at you. These insurance companies are having the same trouble you are generating income and returns. If central banks continue to suppress rates then these companies may find it hard to keep their promises or even stay in business. You will be taking the haircut along with paying their generous fees. There is no silver bullet out there folks. Just good old fashioned hard work, diligence and patience in your investing.

We have been a big proponent and holder of smart beta ETF’s. We have been overweight dividend focused ETF’s and low volatility. They have been generous providers of return so far this year as low volatility, dividend focused ETF’s and utilities have done quite well. When everyone wants in the room – we want out. We are contemplating exchanging those funds as they are now all the rage. They have over the years provided downside protection if markets falter. That may not be the case this time around. We will continue our due diligence. No decision yet. Just an early warning. Chasing yield is a very dangerous proposition. Do your homework and don’t fall for the latest fad.

According to Standard & Poor’s the S&P 500 is now down month and quarter to date while it has maintained a slight gain of 0.13% for 2016. The fourth year of US Presidents second term tends to have below average returns as the market is unsure of who will be the next leader of the free world. Once it becomes evident who the next President is the market will steady. While that outcome is decided it could be a rocky Summer but an opportunity filled Fall.

April is consistently one of the strongest months of the year and that helped returns. However, we are now entering the weakest part of the year from May until November and the election season is not going to help. I think that volatility may be even more pronounced and returns suppressed with Donald Trump in the mix. Not because of his polices or beliefs but because he is bringing a much broader audience to the game and the media is all a buzz. That talk show fodder may convince investors to keep their wallet attached to their hip until things settle down. We have faded the recent rally and continue to cull underperformers and reduce risk. It could be a volatile summer.

Not recommendations just information. Investing is not a game of perfect.  It is a game of probabilities.

 

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.

The Coming Retirement Crisis

It is hard to believe but over twenty years ago while on the floor of the NYSE I asked Arthur Cashin whose work should I be reading. He recommended a, then little known, writer of financial information by the name of John Mauldin. Little would I suspect that over two decades later I would still be enjoying John’s insights. He has access to some highly placed sources and savvy investors. John’s email list for his letter has grown to over 1 million subscribers. It is free so sign up. Here is the link to John Mauldin’s Letter Thoughts from the Frontline.

In this week’s letter John touches on the issue closest to my client’s hearts. When can I retire? We have an expectation in the United States of being able to retire at the age 65 and possibly even earlier. We even base our career success on how many years before 65 we are able to retire. The concept of retirement is a relatively new concept. The advent of Social Security under the FDR administration in 1935 was developed as a safety net for our elderly. The age of 65 was considered because the poverty rate of the elderly in 1935 was over 50%. The life expectancy of a male in the US in 1935 was 59.9 years old.

In 2016 that number has risen to over 76 years of age.

I’ve said this before, but it’s worth repeating: “retirement” is a new concept. For most of human history, people worked as long as they were physically able and died soon thereafter.

Defined-benefit pensions are rare in the private sector and unstable for government retirees. Individual investors tend to lose their money in market crashes and are often lucky just to break even. Even government plans like Social Security are in increasingly questionable shape. – John Mauldin

The answer is pretty simple but it is the one no one really wants to hear. Don’t retire! The reality is that according to the Social Security Administration a man who turns 65 today can expect to live on average to 84.4 years old. A woman turning 65 today can expect to live on average until the age of 86.7. That is just the average. In this day and age of better healthcare and advances in biotechnology one must plan to live until 100 years of age. That is 30 years of retirement if one chooses to work until 70!! That’s a lot of golf.

Ironically, the research pretty much universally shows that many people working past normal retirement age do so for their own personal reasons rather than out of necessity. The data in the United Kingdom, which is not much different from the picture in the rest of the developed world, suggests that almost half the people working past traditional retirement age are doing so simply because they don’t want to stop working. And many people who say they are “retired” still work long hours just to “keep busy.”

Alicia H. Munnell, a Boston College economist who was previously Assistant Treasury Secretary in the Clinton administration spoke recently about the coming retirement crisis in her speech titled, “Falling Short: The Coming Retirement Crisis and What to Do About It.”

Her main thesis is that you should prepare to work longer and yet still enjoy retirement as long as or longer than your parents and grandparents did.

Assuming you started work at age 20, rising life expectancy means that if you retire at age 70 in 2020, you will have the same work/retirement ratio as someone who retired at age 65 in 1940. My generation is enjoying better health in our later years than our parents did. We work longer simply because we can and because we enjoy it.

By Munnell’s calculations, simply working until age 70 will do the trick for most people. The extra working years will give your savings more time to accumulate. Your Social Security benefits will also be higher once you do retire.

JPMorgan’s Marko Kolanovic has been spot on for the last several months as he has picked the bottoms and tops of the market moves since last October. He is out with a different warning this week. He is looking at the market from a more macro perspective and I happen to agree with his thoughts. The next move from governments and central banks may be fiscal policy. It is the only weapon left and it may have serious implications on your investing.

Central banks, Inflation, and Debt Endgame

With the Fed and BoJ meetings behind us, markets are increasingly accepting that central banks are nearly out of options. Central banks can hardly raise interest rates, and there is a growing realization that negative interest rates simply make no sense. Unconventional approaches of buying corporate bonds (ECB) and stocks (Japan) so far have not produced significant results, and run the risk of tainting these assets for private investors. The next attempt to boost the economy or prevent a potential market crisis will likely need to be accomplished by fiscal measures.

Increased government spending, financed by central banks could indeed create inflation, but will further elevate the problem of debt viability. 

We always keep an eye on seasonal factors. The old saw of “Sell in May and go away” harkens back to days when we were an agrarian society. Money was put into the fields in the spring and when harvest came in the fall money was put back into banks and markets. To this day we are creatures of habit. Money managers are likely to take risk off of the table and less likely to put money to work in new ideas because summer is coming. Liz Ann Sonders from Charles Schwab had a recent note on the “Sell in May” theory.

We are in that “season” when you will hear a lot about whether it’s appropriate this year to “sell in May and go away,” which is one of the most time-honored market adages, and for good reason. Since 1950, nearly all of the S&P 500’s gains have occurred between October and April. The mean return since 1950 for the S&P 500 during May through October was 1.3%; while for November through April it was 7.1%.

Markets are also more susceptible to geopolitical developments or changes in monetary policy due to skeleton crews on trading desks in the US and Europe. Moves can be outsized. We will continue to look for opportunities given any developments. In our last blog post we asked you to keep an eye on gold. We feel that investors could find solace here as the games of currency wars and negative interest rates heat up. That has been a good place to be. Inflation is also increasingly on our minds. Not because it is showing up in the statistics but because it will be the only way out for indebted nations around the world. Their only exit from their extreme debt positions will be to inflate away their debt.

Not recommendation just information. Investing is not a game of perfect.  It is a game of probabilities.

 

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.

Roller Coaster Markets

Be fearful when others are greedy and greedy when others are fearful. – Warren Buffett

Well, that was some beginning to 2016! We knew that volatility was coming our way but we did not foresee what happened in Q1. The Dow Jones managed to complete a round trip ticket as we fell 13% and subsequently rose back up 13% in one quarter. That is the biggest intra quarter comeback since the middle of the Great Depression in 1933. Our portfolio strategy coming into 2016 was to tactically manage our asset allocations given that we expected higher volatility and lower returns. Although we didn’t see a round trip in the offing for Q1 of 2016 our strategy worked out quite well. We believe that the rest of 2016 has much the same in store as the market reacts to every nuance emanating from the Eccles Building in Washington DC which is the home of the Federal Reserve Bank of the United States.

We believe that risks are rising after our second 12% rally in months. We have elevated valuations and falling earnings estimates for US companies. It is going to be difficult for the stock market to move higher from here but we cannot bet against continued central bank largesse. The stock market, having rallied 13% off of its recent lows in early February reminds us of a blog post from back in October of 2015. This is what we had to say back in October.

October 2015 will go down as the best performing month for the S&P 500 in four years.  I think that we all enjoyed the ride back up in October. The S&P 500 rallied 8.3% and followed through with more gains today to get the S&P 500 into the plus column for 2015. Those gains would be nice gains for an entire year – never mind a month! Whenever we get to thinking how much we have gained we cannot help but to contemplate the downside. We must always be on guard to temper our greed/ego just as much as we would concentrate on opportunity when fear strikes.

As a reminder, the volatility continued then as well. The S&P 500 closed October of 2015 at 2080. It would be 10% lower by January of 2016.

The key to making money in your portfolio lies in Investor Psychology. Understanding investor psychology and our own personal relationship with money is the key to successful investing.  Having just ridden the roller coaster of emotions that was Q1 we are in a good position to replay how the highs and lows of the market made us feel and how we reacted to it. The two following charts can help you be more successful in understanding how emotions play a role in your investing process.  The first shows two 12% rallies in the last 7 months. The second is a chart of investor psychology. After our second 12% rally in 7 months we should revisit how that roller coaster made us feel. Were you despondent at the lows? Did it make you want to sell and get out or buy more? Are you now relieved? Optimistic? Are you aching to buy more as prices rise?

 

 

In order to be on the right side of the market it is important to sell risk when prices are rising and buy risk when prices are falling. Or in emotional terms, when prices are falling and you are scared ask yourself “What should I be buying”? When prices are rising, ask, what are we selling? Understanding and keeping your emotions in check is the key to making money in markets like these. Ride the roller coaster.

 Valuations

For long time readers and clients you know that one of our favorite metrics of stock market valuation is the US Stock Market Capitalization to GDP. It also happens to be Warren Buffett’s favorite metric in case you wonder why we follow it as well. As you can see from the following chart courtesy of Ned Davis Research the last time that the Stock Market Capitalization as a percentage of GDP was in an undervalued position was in July of 1982.

What changed since the early ’80’s? Central banks gained enormous influence over markets when President Richard Nixon took the United States off of the Gold Standard. This allowed central banks to help manage booms and busts in the economy without being hamstrung by the amount of gold in Fort Knox. Theoretically, they now had an unlimited supply of gold with printed fiat money taking the place of gold. This was the dawn of the Golden Age of Central Banking. The Prime Interest rate from the Federal Reserve reached its high of 21.5% in June of 1982. We have had a steady trend of lower interest rates for the last 30+ years.

Since 1995 (with the exception of February 2009) we have been in the overvalued area of the chart. This chart is evidence of the inexorable influence of central banks on asset prices. Some questions remain. Are we in a permanent state of overvaluation due to the influence of central bankers? If that state of overvaluation is not permanent at what point does central bank influence wane and valuations retreat to historical levels. Also, if central bankers remain in control of markets how low will central bankers allow markets to descend? Given our current inflated valuations we know that based on history we can expect lower returns over the next 10 year time frame.

Another natural question is posed if we feel that returns are to be muted or that prices should retreat. Why not sell out of all our assets and wait things out in cash? I think that the chart also answers that question. We have been in a perpetual state of overvaluation since 1995 – over twenty years!  In order to meet our investing goals we cannot afford to sit out markets until they become more rationally priced. There is also the distinct possibility that markets become even more overpriced. If inflation were to take hold here in the United States investors would want tangible assets that rise in value with inflation. Equity prices could become wildly overpriced.  John Maynard Keynes, the legendary economist once said, “markets can stay irrational longer than one can remain insolvent” betting against them.

We know that it has been a goal of central banks since the dawn of the crisis in 2008 to raise asset prices and therefore raise confidence in the economy but they are now distorting price discovery with monetary policy. This extreme action taken by central banks takes away some of our normal techniques for evaluating markets as markets are warped by policy.

Less Gas in the Tank

Unfortunately, the Federal Reserve has recently discovered with its latest interest rate hike that they are now the WORLD’s central bank and its moves have outsized effects on the rest of the world.  Central banks can pull future returns forward and stall for time so that legislators can enact fiscal policy with which to mend an ailing economy. However, due to reluctance or ineptitude legislators have done nothing and left central banks, and in particular, the US Federal Reserve as the only game in town. If the Federal Reserve raises rates it then weakens other currencies and encourages capital flight. Capital goes where it is treated best. Higher rates of interest in the US and a stronger US Dollar force money to quickly flood out of emerging nations and into the United States. Central banks are stalling for time and currency wars are de rigueur. We have entered a “Twilight Zone” of monetary policy with negative interest rates in Europe and Japan. Central bank officials are also faced with the fact that monetary policy is not immune to the effects of the Law of Diminishing Returns as we enter Year 8 of a bull market in stocks.

Most likely, as risk premiums increase, central banks will increasingly ease via more negative interest rates and more QE, and these moves will have a beneficial effect. However, I also believe that QE will be less and less effective because there is less “gas in the tank.” – Ray Dalio Bridgewater Associates  2/18/16

What’s Next?

And while QE will push asset prices somewhat higher, investors/savers will still want to save, lenders will still be cautious lenders, and cautious borrowers will remain cautious, so we will still have “pushing on a string.” As a result, Monetary Policy 3 will have to be directed at spenders more than at investors/savers. In other words, it will provide money to spenders and incentives for them to spend it.  Ray Dalio Bridgewater Associates

This latest rally saw investors chasing safe haven and dividend paying stocks like consumer staples and utilities. Investors are moving ahead but with caution. Other safe haven assets performed well in Q1 such as US Treasuries, Municipal bonds and Gold. We are also seeing investors maintain cash positions to levels not seen in years. We think that those are good signs. The fact that investors have sought and are seeking shelter will provide some cushion to any market tumble. Investors are preparing for another 2008 style crash. That, in essence, is why 2016 is NOT 2008.

Clients have been asking what metrics we are looking at as far as taking more equity risk. The 200 Day Moving Average (DMA) is the Maginot Line when it comes to seeing markets as bull markets or bear markets. Obviously, we would take more equity risk if we felt that we are in a bull market. Currently with the S&P 500 in a battle to take flight above its 200 DMA we are inclined to believe that we are still in a bear market and continue to hedge risk. If the bulls can get above and stay above the 200 DMA in the S&P 500 we would be more inclined to changing our mindset.

Oil’s bounce is alleviating pressure on borrowers and drillers but prices need to get back above $50 a barrel to really stop the pain. Currently, as we write West Texas Crude is below $40 a barrel. The selling of oil and oil related debt may be easing for now but the pain may only be delayed. High yield debt has seen money pour into that sector in the last month. Investors may be catching a falling knife there with more pain to come if oil cannot continue its recent rally.

We will continue to tactically change our asset allocation as the S&P 500 stays range bound between 1800-2100 and volatility continues its resurgence in 2016. We continue to hold bonds as it has been the most unloved of asset classes for the last several years as short sellers have been betting on rising interest rates and falling bond prices. In Q1 of 2016 bond returns have been in excess of 2% which is a very nice quarter for bonds. We see bonds as having value while the US 10 year yield is still north of 1.8% as we write while Japanese 10 year rates are less than zero. We feel that there is still adequate return to entice capital from around the world into US government bonds at 180 basis point spreads.

We cannot predict with 100% accuracy every move in the market but what we can do is try and profit by tactically allocating and hedging our portfolio in times of market stress to take advantage of market volatility. Investing is not a game of perfection but of managing the risk inside one’s portfolio. We do not jump in and jump out of the market wholesale. By divesting ourselves of overpriced assets and availing ourselves of opportunities when prices are low allows us to take advantage of the long term benefits that the math of compounding brings.

We still foresee 2016 as being a tactically driven year. We feel that changing our positions tactically with the ebb and flow of the market, decreasing the volatility of our portfolios by increasing positions in bonds and bond like instruments while also paying attention to companies that have pricing power like technology and health care will be the key to performance. Cash is also an important part of asset allocation because although it returns zero when risk premiums rise its value will be seen in its inherent call optionality and the opportunity set that it provides given lower asset prices.

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 CEO of Goldman Sachs

 

 

Ride the Wave

So much has happened and so much to talk about. We could talk about the seemingly globally coordinated easing from central banks around the globe. Central banks easing policy in the last two weeks have included Norway, Sweden, the Bank Of Japan (BOJ), the European Central Bank (ECB), the Chinese central bank and of course our own recent dovish statement from the US Federal Reserve,. We could talk about how that has led to a weaker US Dollar which in turn has helped oil, precious metal and emerging markets stage a turnaround in fortunes. Or perhaps we should discuss how Central bank maneuvers have helped US markets regain all of the ground they had lost so far in 2016.

We could talk about all this but here is what we think would be most useful right now. The key to making money in these markets lies in Investor Psychology. How we understand it and our own emotions when it comes to investing our money is the key to success.  Here are two charts that can help you be more successful in understanding how emotions play a role in your investing process.  Courtesy of CNBC, the first chart shows two 12% rallies in the last 7 months. The second is a chart of investor psychology. After our second 12% rally in 7 months you should ask yourself, Where are you on this chart? Are you relieved? Optimistic? Thrilled? Sell risk when prices are rising and buy risk when prices are falling. Understanding and keeping your emotions in check is the key to making money in markets like these. Ride the wave.

Be fearful when others are greedy and greedy when others are fearful. – Warren Buffett

 

 

 

If the Dow Jones holds its gains for the next two weeks we will have seen the biggest quarterly comeback in stock markets since 1933. We don’t have to remind you that the 1933 rally took place smack in the middle of the Great Depression. Risks are rising after our second 12% rally in months. It is going to be hard to move higher from here but don’t bet against continued central bank largess. The stock market is up 12% in 26 trading days. Not bad. But it does remind us of a blog post from back in October of 2015.

October 2015 will go down as the best performing month for the S&P 500 in four years.  I think that we all enjoyed the ride back up in October. The S&P 500 rallied 8.3% and followed through with more gains today to get the S&P 500 into the plus column for 2015. Those gains would be nice gains for an entire year – never mind a month! Whenever we get to thinking how much we have gained we cannot help but to contemplate the downside. We must always be on guard to temper our greed/ego just as much as we would concentrate on opportunity when fear strikes.

As a reminder the S&P 500 closed October of 2015 at 2080. It would be 10% lower by January of 2016.

Central bank policy in Europe and the US is having the same effect. Earnings estimates are heading lower while stocks ride higher. Not a great recipe for success. Risk is rising.

We cannot predict with 100% accuracy every move in the market but what we can do is try and profit by tactically allocating and hedging our portfolio in times of market stress to take advantage of market volatility. Investing is not a game of perfection but of managing the risk inside one’s portfolio. We do not jump in and jump out of the market wholesale. By divesting ourselves of overpriced assets and availing ourselves of opportunities when prices are low allows us to take advantage of the long term benefits that the math of compounding brings.

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.

Warren Buffett’s Favorite Metric

Warren Buffett’s favorite metric for the market over the years has been the Ratio of US Market Capitalization to United States GDP. Here is a copy of it below from Ned Davis Research. Ned Davis Research is one of the best independent research outfits in the business and I have followed their insights for over 25 years.

What I find fascinating about this chart is the high levels of valuation since the mid 1990’s. I believe that this time period should be considered the Golden Age of Central banking. This was the Era of Greenspan and the Greenspan Put. Alan Greenspan was the Chairman of the US Federal Reserve Bank from 1987-2006. It was Greenspan that realized the power of central banking. Central bankers in previous eras did not have the tools at their disposal to manage monetary policy as effectively as Greenspan. It was the removal of the Gold Standard by Richard Nixon which allowed central bankers in the US to pull forward growth in order to manage downturns more effectively. Note however that since 1995, valuations in the market have exceeded the average levels consistently with the exception of the 2008 crash. That leaves us with some very big questions. How long can central bankers keep pulling forward returns? How long will markets continue to give higher than normal valuations to markets based on central bank policy? Ned Davis Research

The one era most like our current one is that the late 1936 – early 1937 period. Current high levels of Price Earnings ratios, and, historically low 10 Year yields combine in a disturbing stew now as they did in 1937. Coming out of the Great Depression Federal Reserve officials saw prices in the stock market build to uncomfortable levels and with inflation on the horizon began to raise interest rates. The first tightening in August 1936 did not hurt stock prices or the economy, as is typical.

The tightening of interest rates was made worse by currency wars as European nations chose to move in the opposite direction of US monetary policy. The world began to demand US Dollars and gold. As inflation picked up to 5% the Federal Reserve raised rates further in March of 1937 and again in May 1937. This tighter monetary policy reduced liquidity and sent bond and stock prices much tumbling. Stocks would bottom a year later down 50% from prior levels.

Given the high level of valuations in the Golden Age of Central Banking how will assets perform if the Federal Reserve wants to exit the policies that brought forth those valuations? Central bankers may find that The Golden Age of Central Banking may give way to the Roach Motel of Central Banking. They can get in but they cannot get out.  It’s all about how markets react to the second and third rate hikes.

In our last blog post we mentioned the key levels for the market and now we are there. The bulls did not have much trouble surmounting the 1940 level but 2000 may prove more difficult.

The next level for the bulls is the 2000 number on the S&P 500 and then 2020. We have a confluence of moving averages and resistance zones to overcome here but the bulls have the bears on the run and shorts are covering as they feel the pain.  The risk at the moment is skewed to the downside as we have come very far very fast since the lows of 1812 in mid February. The market is extremely overbought and needs to rest. Let’s see if the bears can push back the bulls. Markets are looking for central bank intervention and if not from China this weekend then perhaps the ECB next week. Shorts are feeling the pain and the bulls may have their hearts set on 2100 on the S&P

Clients have been asking what metrics we are looking at as far as taking more equity risk. The 200 Day Moving Average (DMA) is the Maginot Line when it comes to seeing markets as bull markets or bear markets. Obviously, we would take more equity risk if we felt that we are in a bull market. Currently with the S&P 500 below its 200 DMA we are inclined to believe that we are in a bear market and continue to hedge risk. Let’s see if the bulls can get above and stay above the 200 DMA.

Oil’s bounce is alleviating pressure on borrowers and drillers but prices need to get back above $50 a barrel to really stop the pain. Forced selling of oil and oil related debt may be easing for now but the pain may only be delayed. High yield debt has seen money pour into that sector in the last week. Investors may be catching a falling knife there with more pain to come.

In our last blog post we asked you to keep an eye on gold. We feel that foreign investors could find solace here as the games of currency wars and negative interest rates heat up. That continues to be the case. Gold has been the star of 2016 and this week was no different. The yellow metal may be due for a rest but it might a short one. Negative interest rates in Europe are helping as are the concurrent currency wars between Japan, China, the US and Europe. Hold on tight and keep an eye on gold. Ray Dalio was at the University of Texas this week telling retail investors that they should consider holding 5% of their assets in gold. Look at Sprott Physical Gold Trust (PHYS) ETF and SPDR Gold Trust (GLD) ETF if you are determined to hold gold in your portfolio. PHYS has had better performance this year than GLD.

Not recommendation just information. Investing is not a game of perfect.  It is a game of probabilities.

 

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.

30 Second Timeout

 

Investors are breathing a sigh of relief as the S&P 500 has bounced 5.9% off the lows of 2016. It was almost as if a starter’s gun was fired the morning after New Year’s 2016 and investors have been racing ever since. Now, investors have been granted a 30 second timeout to catch their collective breath. It might be time to get back on the court.

The S&P 500 closed Friday at the 1917 level. The bears will look to stop the bulls advance at first 1940 and then 2000. The S&P has returned to the 1812 level several times now and that is the space that bulls must defend. Technical analysts are calling attention to that level as any breech of 1812 could propel markets lower. As the price of oil continues to stay below $40 more and more pressure will be brought to bear on oil companies to pay back debt and there will be pressure as well on the banks that hold that debt. Round and round she goes as negative pressure begets increased negative pressure and lower prices beget lower prices. Those forced to sell will be selling into a spiraling lower price and be forced to sell more assets to raise capital. For now, the risks still seem to be leaning to the downside. Credit risk is rising.

We are seeing investors fleeing stocks and moving into safe haven assets such as US Treasuries, Utilities, Municipal bonds and Gold. Jeffrey Gundlach, the current Bond King, has been prescient in his market call of late and has stated that Muni bonds may in fact be overbought at this time. It shows the level of fear that investors have gotten themselves to. We are also seeing investors raise cash positions to levels not seen in years. We think that those are good signs. The fact that investors have sought and are seeking shelter will provide some cushion to any market tumble. Markets are preparing for another 2008 style crash. That, in essence, is why 2016 is NOT 2008.

We have been underweight equity allocations and heavily overweight cash.  We have also been using volatility as a hedge this year and that has worked out quite nicely. We sold our hedges as stocks bounced off of their more recent lows and are currently un-hedged (other than cash positions) but that could change at any time. Hedging is like insurance. It costs money but you will appreciate having it if the house burns to the ground. It sounds easy and without risk but it is not and the use of hedges must be done judiciously. Tactically applying portfolio hedges at the appropriate times will allow us to outperform in a down market.

Remember, markets go down far faster than they go up. We are not making predictions here. Investing is not a game of perfect.  It is a game of probabilities. Keep an eye on gold. Foreign investors could find solace here as the games of currency wars and negative interest rates heat up.

 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.

Where to Place Your Bets

 

Speaking to clients this week all the talk was about the Super Bowl, the election and how far markets have to fall. First of all, let’s just get the Super Bowl talk out of the way. We are of the sentimental type and are wishing that as this is Peyton’s Manning’s’ last rodeo we hope that he gets to go out on top. Having said that Barack Obama is in his last rodeo as Commander in Chief and statistically speaking, last rodeos by second term President have never been very good for markets.

Markets hate uncertainty. By not knowing who will occupy the White House in January market participants do not know where to place their bets. According to Sam Stovall over at S&P IQ the fourth year of a second term President is up only 44% of the time versus the average year of being positive 66% of the time. The returns, as you might expect, are also subpar. The average fourth year of a second term US President is down 1.2% versus the average stock market return of 7% since 1900. If the market players do not know who is going to be President they do not know where to place their bets. For example, if a Democrat were to occupy the White House in January market players may bet on wind and solar. If, on the other hand, a Republican is in the White House beaten down coal companies might be a good bet. So you see it is not Hilary vs. Trump that has the market in a tizzy. It is the uncertainty. The market is agnostic on the race for the White House. It just wants to know which way to bet.

We have said in prior posts that it is really all about the Federal Reserve policy unwind that is moving markets but it does have other co-conspirators. The other underpinnings of doubt are the race for the White House, China and the price of oil. As those underpinnings become resolved the market can regain its footing because in becoming resolved they may precipitate a sharp fall in asset prices which could change Federal Reserve polices.

How far could prices fall? Again from Sam Stovall, we see some excellent statistical information in the following graph.  A bear market is conferred when stocks fall 20% from their peak. The peak of our current market was seen on May 21^st of 2015 at the price level of 2130 on the S&P 500. The average bear market since the end of WW II falls 32.7% while taking 9 months to fall 20% and 14 months to eventually hit its bottom.

 

 

Looking at Mr. Stovall’s chart what stand out to us is the 1968 – 1982 period. Much as the 1966-1982 period we believe that we are in a secular bear market. Much like the 1966-82 secular bear we have had two Mega Meltdowns. If history does not repeat but rhyme we could enter our third cyclical bear market of the 2000-2018 secular bear market and we would expect it to mimic the 1980-1982 bear market. We believe that we may be entering what S&P IQ would term a Garden Variety bear market. Those averages would call for a 26.4% down move from the peak that would last 14 months in duration. The 1980 bear market lasted 20 months and was lower by 27.1% from its peak. Numbers such as those would put our markets at 1555 on the S&P 500 in July of 2016.

We are not finding many bulls in the market right now. That alone tells us that investors are prepared after two Mega Meltdowns in the last 16 years. If we are to have a bear market we think it far likelier that we will have one of the Garden Variety and this summer investors may have a better idea of where to place their bets.

As investors we create scenarios and try to invest appropriately. Using this information we have had lower than normal equity allocations and higher than average cash positions. We are also currently hedging our equity allocations for our more aggressive clients. That should allow us to outperform in a down market. Remember, markets go down far faster than they go up. We are not making predictions here. Investing is not a game of perfect.  It is a game of probabilities.

 

 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.

The End of the World

The end of the world is a terribly bad bet but yet television pundits were out in force last week proclaiming the beginning of a bear market and perhaps the end of the world as we know it. The definition of a bear market is a market that is down 20% from its highs. At the S&P 500’s lows last week the market was already down 15%. It doesn’t take a rocket scientist to predict that the market has a 50/50 chance of going down another 5%.

The reason that the pundits are out and about screaming like Chicken Little is that they were not prepared for a move lower in asset prices. We, on the other hand, had lowered our equity allocations and raised our cash position. That way we were prepared to outperform given a sharp move lower while having excess cash to deploy given better valuations and cheaper assets. Being an asset manager is a lot like being in charge of buying the groceries. If one is in charge of buying the groceries you haven’t done your job appropriately if when going to the grocery store and finding New York Strip marked down 15% you don’t have any cash in your pocket.

We have been underweight equities and overweight cash for some time now seeing an overvaluation in asset prices. This overvaluation in asset prices coupled with the unintended negative consequences of the Federal Reserve’s zero interest rate policy led us to surmise that a re-pricing of assets was in order. While underweight equities at that time we did not feel as though we would miss any truly outstanding returns. Given stretched equity valuations it seemed far better for us to have some insurance in case markets headed lower. Markets go down far faster than they go up and any underperformance is quickly made up with an outsized cash position. Suffice to say 2016 has been a boon to relative performance if one was prepared for this correction in the markets.

Howard Marks latest missive came across my desk this week and as my long time readers know I read everything from Mr. Marks that I can find. He is one of the great investing minds of our time and is kind enough to share his thoughts on investing. Mr. Marks has warned for some time that valuations were a bit rich by telling us to “move forward, but with caution”. It is now that he sees better values. While not saying that now is THE time to buy he does mention that now may be A time to buy.

As I mentioned above, since the middle of 2011 – by which time the quest for return had resulted in rather full prices for debt, over-generous capital markets and pro-risk investor behavior – Oaktree’s mantra has been “move forward, but with caution.”  We’ve felt it was right to invest in our markets, but also that our investments had to reflect a healthy dose of prudence.

Now, as discussed above, investors’ optimism has deflated a bit, some negativity has come into the equation, and prices have moved lower.  Depending importantly on which market we’re talking about and how it has fared in recent months, we consider it appropriate to move forward with a little less caution. – Howard Marks

 

We have fielded a larger number of calls this week from concerned clients and we take our role as counselor seriously.  Being in tune with one’s emotions is probably the most important criteria for investing success. As a former specialist on the NYSE it was our job to be a provider of contra liquidity. That is to say it was our job to be buying when others were selling and selling when others were buying. It was a great training ground to understand one’s own emotions and of the potential madness in crowds. It trained me to have a contrarian viewpoint. When confronted with excessive buying or selling by market participants it naturally became an instinct to question the extreme nature of the emotions driving that buying or selling.  It is not to say that the crowd was always wrong or that we do not feel the emotions of fear and greed. It is that we are keenly aware in that moment to be objective in our approach and to recognize when there is fear or panic in the sellers mind and act appropriately. By being aware of one’s emotions one can more easily use others fear or greed to profit.

That’s one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not so hot.”  But in the world of investing, perception often swings from “flawless” to “hopeless.”  The pendulum careens from one extreme to the other, spending almost no time at “the happy medium” and rather little in the range of reasonableness.  First there’s denial, and then there’s capitulation. Howard Marks – Oaktree

The same concern seemed to be repeated one every client call this week. “Is this 2008 all over again?” Quite frankly, I don’t believe so. I think that this situation is different. I think that most investors are suffering from recency bias. Recency bias is the tendency to think that trends and patterns that have happened in the recent past will occur again. Investors burned by the 50% downturn in the Internet Bubble of 2000 and the 50% downturn in the Housing Bubble of 2008 are afraid that we are at that same precipice again. I do not have a crystal ball but I do not see the same excesses in current markets as I saw in 2000 and 2008 but I do see investors preparing for a coming storm. If investors are prepared then the storm effects will not be as bad as when they were not prepared in 2000 and 2008. Furthermore, it is our perception that there are overvaluations that need to be corrected but not bubble type excesses. Even in the oil sector there were not bubble like valuations but just simply a misallocation of resources due to Federal Reserve zero interest rate policy. The negative implications of which have obviously come to pass. It also seems that while the bursting of the Housing Bubble in 2008 did bring us to the brink of a global meltdown that was mostly due to the weak balance sheets of US banks. That is no longer the issue that it was in 2008 as the Federal Reserve has made sure that bank balance sheets, at least here in the US, are much less vulnerable than they were in 2008.

So let’s all back away from the ledge. It is not the end of the world as we know it. If we can understand our fear and use it to our advantage we will be better off for it in the long run. We are positioned appropriately and looking for that New York Strip to go on sale.  We will continue to maintain albeit somewhat higher levels of cash as equity valuations continue to become more reasonable and put those dry powder funds to work. We think it will be prudent to avoid exposure to momentum stocks and continue to rotate into more reasonably valued shares.

 

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.