Riding the Waves

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

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

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

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

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

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

VOLATILITY – Resurgence?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

INFLATION VS DEFLATION The Debate Rages again

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

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

VALUATIONS

BIRINYI

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

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

GRANTHAM

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

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

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

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

 RIDING THE WAVES OF VOLATILITY

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

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

BOY SCOUTS

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

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

 

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

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

Inflation and Volatility Making a Comeback?

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

 

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

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

 

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

Fed Concerns and Market Melt Up

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

And They Danced

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

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

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

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

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

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

Perceived Discrepancies with New Highs

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

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

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

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

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

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

 

Volatility and Goldilocks

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

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

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

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

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

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

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

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

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

Who Could Have Seen This Coming?

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

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

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

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

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

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

Should be an interesting summer.

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

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

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

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

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  
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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  
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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.

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.

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