S&P To Triple in 2018

If you read our Quarterly Letter you know that the overriding question is at what level will bond yields begin to hurt stocks? Well, courtesy of “Bond King” Jeffrey Gundlach we have a number. Gundlach held his yearly January conference call this week which is always fascinating and filled with thought provoking ideas. In his conference call Gundlach stated that the 2.63% level on the 10 year is going to be a very important level and at which stocks may begin to suffer. The 10 year closed the week at 2.55% but touched a high of 2.597%.

I have spent the better part of the weekend in the office reading interviews with investing mavens and re-listening to conference calls, much to the chagrin of my wife. This week we heard from Jeffrey Gundlach, Bill Gross and Jeremy Grantham, all of whom we value highly in their opinions. If you have time check out Grantham’s latest missive titled “Bracing Yourself for A Melt Up”.  We, of course, agree with Grantham as we have been calling for a melt up in the markets since November 2017 and its subsequent 30% mark up. He makes what we believe are salient points in regards to his concept of bubbles and his feeling that one critical component is the acceleration of prices. Turning points in markets happen very quickly. That is why we stay invested. This melt up could run much further, higher and faster than any of us can predict. That is why we stay invested and simply recalibrate our allocations.

Another reason we have spent so much time in the office this weekend is that we believe that we are on the cusp of a regime change in markets. That regime change could spell the end of the bond bull market of the last 30 odd years and see a reemergence of inflation. Jim Paulsen, Chief Investment Strategist from the Leuthold Group had this to say back in November on the regime change.

“As financial markets are weaned off the juice they have been drinking for almost a decade, investors should prepare for a very different bull market in the balance of this recovery,” he said. “Without a chronic injection of financial liquidity, the stock market may struggle more frequently, overall returns are likely to be far lower, and bond yields may customarily rise.”

To be sure, Paulsen is not predicting a market collapse. Instead, he suggests investors will need to shift strategy away from the cyclical U.S.-centric approach that has worked for most of the past 8½ years, due to the likely contraction of money supply compared to nominal GDP growth.

That means value over growth stocks, international over domestic, and inflationary sectors, like energy, materials and industrials, over disinflationary groups like telecom and utilities.

Here is what Dr. Ben Hunt at Epsilon Theory had to say on inflation and QE back in July of last year.

(As the Fed slowly raises rates) It will force companies to take on more risk. It will force companies to invest more in plant and equipment and technology. It will force companies to pay up for the skilled workers they need.

In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory.

My view: as the tide of QE goes out, the tide of inflation comes in. And the more that the QE tide recedes, the more inflation comes in.

Dr. Ben Hunt Epsilon Theory

The timing on Trump’s tax reform is a bit late in the cycle and may end up exacerbating inflationary pressures. Central bankers have been pouring gasoline on the pyre for years with no effect. Pushing on a string. Higher rates (and tax reform) may be the match and with too much gasoline on the fire inflation may be the result.

(the economy) “will be getting an extra boost in 2018 and 2019 from the recently enacted tax legislation” which could lead to overheating. In which case, it would be necessary for the Fed to “press harder on the brakes”  –

NY Federal Reserve President William Dudley

The combination of higher rates, the end of QE and tax reform may push the market and economy into overheating. Late stages of bull markets tend to be very kind to commodity plays and we are beginning to see movement in the typical commodity plays. Transports are off to their best start since 1983. The S&P is off to its best start since 1987 while the Dow is off to its best start since 1997.At its current rate so far in 2018 the S&P 500 will triple by the end of the year. Not entirely likely. According to one of the many sentiment indicators that we follow the bulls are partying like it is 1987. It is starting to feel more like 1998-99. Watch for price acceleration.

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/ .

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.

Advertisements

Paradox

 The catch is, a boat this big doesn’t exactly stop on a dime.

Seaman Jones – Hunt for Red October

 Whenever you find yourself on the side of the majority, it is time to pause and reflect. ~ Mark Twain

Paradox

The word of the year just might be paradox. In a normal year the market is full of conflicting information and contradictory conclusions. 2018 and its historical asset valuations may set a new bar when it comes to investing paradox. A recent Bank of America Global Fund Manager survey shows a record high number of managers feel that stocks are overvalued yet cash levels continue to fall. The upshot is that even though managers feel that markets are overvalued they are forced to chase the market ever higher and deploy their cash holdings. An explanation for this data point is that managers act in this way in an effort to provide themselves with insurance against career risk. Chasing markets higher can be, in itself, just an effort to assuage investors who see the market returns and expect the same despite manager’s historical models telling them to act more cautiously.

One data point that simply jumps off of the page from the fund manager survey is that close to 70% of fund managers believe that tax reform will lead to higher stocks in 2018. If 70% of managers feel that tax reform will lead to higher stock prices, and the stock market is a discounting mechanism, then shouldn’t that idea already be factored into stock prices? In a world where for every buyer there is a seller 70% is practical unanimity.

Here is yet another paradox. Low rates are a commonly ascribed reason as to why equity valuations are so high. Doesn’t everyone expect rates to rise in 2018 including the Federal Open Market Committee (FOMC)? The FOMC itself has stated that they expect to raise rates three times in 2018.  If it is widely expected that rates will rise and low rates are the reason for expensive equity valuations then shouldn’t equities be falling? We are left with the idea that the current market is in melt up mode due to the twin engines of human psychology and market structure.

New Regime

Current market structure is built on self reinforcing algorithms engineered by computers. Computers run by market makers see buy orders and place other buy orders ahead of clients in order to implement more liquidity into the system. Market makers, by design, restrict themselves as to how much capital they put at risk. At a certain level, dictated by management, a market maker will cover their short or dispose of their long in order to manage risk. A high and rising market will lead to a market maker buying more and a lower market will lead to a market maker dumping their position into a falling market. That leads to self reinforcing loops. We now find ourselves in an era with lower volatility and grinding markets with self reinforcing feedback. While we believe that the lower volatility regime is partly a response to the lower human emotional component of investing the emotions are still present and impactful.  Investors currently find themselves chasing the market ever higher as their models have told them to reduce their allocations to stocks but yet stocks push ever higher and clients demand higher returns. Hence, another self reinforcing feedback loop.

“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.”- Janet Yellen FOMC Chair Jackson Hole 8/25/17

We are currently seeing record low volatility with continued rising asset valuations, all while being in an era of experimental monetary policy attempted globally for the first time in history. After conducting their experiment of adding liquidity to ward off the greatest financial crisis since the Great Depression central bankers have now begun to drain liquidity and lift interest rates.

Prices of bonds and stocks continue to advance further away from median historical valuations. That tells us that there is too much money in the system and it needs to be drained. The Fed and BIS (Bank of International Settlements) see that too and are anxious to drain or, at the very least, stop adding liquidity. That tipping point of global central bank balance sheets draining liquidity instead of adding may happen sometime in the summer of 2018 if markets allow.

Central bankers have never attempted this before and will now, in the next six months, begin to attempt the most difficult part of their act. In the face of this never before attempted trick by central bankers we find investors are taking on even more risk.  Are investors waiting to see who runs for the door first in an elaborate game of chicken? “Prices are still rising. I can’t sell. I will miss out. I will get out before the other guy.” It will be a small door when the music stops. It’s like the boiled frog. A frog will jump out of a hot pot but put him in a cool pot that slowly boils he won’t perceive the danger until it’s too late. Investors are the frog as central banks slowly raise interest rates and drain liquidity. They won’t know what hit them. Note the following quotes (courtesy of ZeroHedge) from Jerome Powell, the newly appointed Chair of the FOMC, from the FOMC Minutes in October of 2012.

[W]hen it is time for us (the Federal Reserve)to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. – Jerome Powell FOMC Committee Minutes October 2012

 

Moral Hazard

I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. – Jerome Powell FOMC Chair FOMC Minutes Oct 2012

Since the election of Donald Trump in November of 2016 we have postulated that we were on the precipice of a melt up in stocks. Since that time we have seen the S&P 500 rally by over 28%. It was not the election of Trump that led to that thought process it was an amalgamation of set points that had come together at that instant to provide the fuel for the rally. The election released the Animal Spirits of the market. We felt that investors would be spurred by the idea that deregulation, tax reform and infrastructure spending would lead an economy, which was primed and ready, to go to greater heights. But most importantly, the groundwork for this rally was put into place prior to the election by the members of the FOMC. What the FOMC had put into place was similar to kindling and gasoline looking for a spark and that spark arrived in the form of tax reform and deregulation.

The above quote from Powell deserves to be read again. By engineering QE, the FOMC took steps to actually encourage risk taking and, with that, the FOMC had created a moral hazard. Moral hazard is the idea that investors could and should count on the Federal Reserve to effectively bail them out if things went wrong. Investors have been trained to think that if there is a significant selloff in the market then the Fed will add liquidity. Perhaps even begin a new round of QE if the selloff is bad enough. That leads investors to think Why Sell? No one sells. The market just heads higher. People have adjusted to the new paradigm. Whenever the market gets in trouble the Fed bails it out. 1987. 1998. 2001. 2007. 2011.2012. 2015. That has investors asking “Why EVER Sell”?

The moral hazard of the Fed gave rise to what became known as The Greenspan Put. The put was the level in the market, which if the market ever fell to, the Federal Reserve would ride to the rescue, add liquidity and save markets from themselves. The Federal Reserve gave no reason for investors NOT to take on risk and substantial risk at that.

Another factor in the rise of animal spirits has been the parabolic rise in the price of bitcoin and the mania surrounding it. It has helped drive investors to an extreme in bullishness anticipating future investing profits. Now, bullishness in itself is not bad and, in fact, an extreme level of bullishness can portend further gains but we do believe that it sets markets up for difficult comparisons. Most major tops and bottoms in the market in recent years have what is seen as a negative divergence in its level of Relative Strength (RSI). We are currently seeing extreme levels of RSI in the broader market. Having hit this level of extreme bullishness we should see some sort of selloff or just a breather in markets rise. Having had that breather when we approach these levels again comparisons become very difficult. If those levels of bullishness do not hit prior levels investors may see that as a negative divergence and begin to take off risk. Bitcoin’s parabolic rise is a sign of mania in markets and caution should be paid. The FOMO Fear of Missing Out has investors, perhaps, getting in a little over their heads.

Giddy Up and Getting Giddy

We learn far more when we listen than when we talk so when smart people talk we listen. David Swenson is the Chief Investment Officer of the Yale Endowment. He is seen as the Michael Jordan of endowment investing. We have rarely seen interviews of him but we came across this one in November of last year at the Council on Foreign Relations. He was interviewed by Robert Rubin the former US Treasury Secretary and CEO of Goldman Sachs. My take on “uncorrelated assets” is that a good portion of what he is talking about is cash or cash like instruments that do not move with the stock market.

RUBIN: Did I hear you say that you have 32 percent now in uncorrelated assets?

SWENSEN: That’s correct.

RUBIN: More than you had in ’08, when we were in recession?

SWENSEN: Slightly more, yeah.

RUBIN: Do you think we’re in recession, or what scares you that you really want to have a recession-level of cash?

SWENSEN: Yeah. So I’m not worried about the economy so much. I have no idea what economic performance is going to be over the next five or 10 years. What I’m concerned about is valuation. I think when you look at pretty much any asset class anywhere in the world, it feels expensive. And the handful of areas that I talked about where I thought there were opportunities are kind of niche-y—short-selling, Japan, I think there’s some opportunities in China and India, although it’s hard to call either of those markets screamingly cheap either. So it’s really a question of valuation, not a question of economic fundamentals.

For now we ride markets higher. We ride them higher with lower equity exposure and lower durations but ride them we must as our clients need a return on their assets to provide for current and future liabilities.  But we grow in caution as giddy investors confidence grows with their account balances. We are concerned because valuations are historically high because interest rates are historically low. If we believe that asset valuations are a derivative of the risk free interest rate then shouldn’t valuations be falling as interest rates are rising? Or, perhaps, valuations will just drop off a cliff when interest rates hit some theoretical number? Will it be 3% on the 10 year? 4%? 5%? No one knows this theoretical number so is it not prudent to scale back your risk allocation given that higher interest rates are on the way? The frog is in the pot. The water is getting warmer. You cannot plan to get out before everyone else. We recalibrate our risk perspective. The trick is that human nature has us chasing higher and higher equity prices because we have fear of missing out.

The market is a massive naval ship running full steam ahead. It doesn’t stop on a dime. The markets could continue to rage. We recalibrate and adjust our asset allocations because when turning points come they will come quickly and seemingly come out of the blue. The Fed cannot react to every market twitch and if they are truly dedicated to reducing their balance sheet then they will have to raise their pain threshold and that makes the Fed Put lower (and more painful) in terms of the level of the S&P 500. For now we recalibrate, accept slightly lower rates of return and brace for a shock with non correlated assets as our cushion.

We continue to believe that central bank purchases will dictate asset pricing and while we can try and predict when asset flows will turn negative we cannot predict when markets will react to that reversal in flow. For now buy the dip still reigns while volatility selling strategies are de rigueur. In a self reinforcing loop the current paradigm reflects an assumption of the continuance of the status quo and trades built upon that will grow ever higher in AUM. That will make the break all the more painful and swift.

 What’s Next?

In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”– Rudiger Dornbusch

Since November of 2016 we have postulated that we were on the verge of an animal spirits led melt up and we projected that much like 1987 we would see a 30-35% rally in markets before a letdown in prices. We may have underestimated the animal spirits. A strong 2017 followed by a strong start to 2018 could lead to further gains. We may also have underestimated current market structure as it may be causing markets to have longer, less volatile regimes and that regime change may become less and less frequent.

We feel that while we are in the late stages of a bull market it is best to pull back on risk and while late stages of bull markets can see spectacular returns we nor anyone else knows when that comes to an end. So for now we are in it to win it but just a little less in.

2018 has come in like a lion. We think that a correction in 2018 is likely and how the Federal Reserve responds to that correction is likely to determine how long and how deep that correction is. Tax reform is priced in and economic news has been positive. While those positives are now baked in the cake disappointing actual results from tax reform could impact pricing. Also, impact could be felt from rising bond yields as investors seek safe haven in bonds over stocks. This week the rate on the 2 year bill rose above that of the S&P 500 yield for the first time since 2008. Investors may begin to see bonds as an alternative to equities. If a correction should come we would expect it to be sharp and scary but will set equities up for another leg higher in 2019 and beyond.  We believe it is prudent to be a bit more conservatively positioned this late in the cycle and expect lower returns in order to be prepared to profit from others panic and flawed market structure.

As investors, our job is NOT making the case for why markets will go up. Making the case for why markets will rise is a pointless endeavor because we are already invested. If the markets rise, terrific. We all made money, and we are the better for it. However, that is not our job. Our job, is to analyze, understand, measure, and prepare for what will reduce the value of our invested capital. –Lance Roberts

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

 Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks…During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.Warren Buffett

5845 Ettington Drive

Suwanee, Georgia 30024

678-696-1087

Terry@BlackthornAsset.com

Disclosure: According to SEC Custody Rule 206(4)-(a)(2), Blackthorn urges you to compare statements/reports initiated by your Blackthorn with the Account Statement from the custodian of your account for data consistency. To that end, if you find any discrepancy between these reports and the statement(s) that you received from your account’s custodian, please contact your Advisor or custodian. Also, please notify your Advisor promptly if you do not receive a statement(s) from your custodian on at least a quarterly basis.

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.

Tax Reform Win – Pre Pay Your Taxes

We had a blog post written but felt that this time sensitive information was way too important not to share. Some sharp eyes have found away to take advantage of the tax reform bill in 2017 for 2018. Pre Pay your Property taxes especially if you live in a high tax state – NY, NJ, CA. Take a look!

NY TIMES (Click on Picture for link)

 

BitCoin

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

The most important aspect of investing to master is the psychology of investing. If one is not aware of one’s emotions surrounding money and gains and losses one can never master the art of investing. The parabolic price rise and constant chatter surrounding the rise of bitcoin has all of the hallmarks of a mania. The bitcoin mania has pundits and media types all aflutter. That emotion works its way into mainstream investing.

We are seeing very large money flows into the market as investors see the big returns of bitcoin and want some for themselves. That reminds us of another Warren Buffett quote. “What the wise man does in the beginning the fool does in the end.” According to CNBC, ETF inflows had their second biggest week in history. We believe that the parabolic rise in the price of bitcoin and the mania surrounding it has driven investors to an extreme in bullishness. That has led to the S&P 500 becoming overbought (According to its RSI) to a level not seen since 1995. Investors are plowing money into stocks excited by bitcoin’s parabolic rise. The FOMO Fear of Missing Out has investors, perhaps, getting in a little over their heads.

For months we have mentioned the idea that the market could stall at the 2666 level on the S&P 500. We made mention of the fact that 2666 is just about 4 times the bottom print in March of 2009 of 666 on the S&P 500. Also, our thesis included that this number, and its biblical significance, would play a part in Wall Street traders psychology and in Quantitative Funds computer programs. For those of you who thought we were nuts, by way of Zero Hedge, comes a chart which shows that the market has struggled with multiples of 666 since March of 2009. The S&P 500 when hitting 2x and 3x the low of 666 has spent the next 18-24 months in a consolidation pattern. Signposts like this along the way are good spots for investors to take a respite and reflect on how far we have come and whether the trend should continue. 2018 may be a Year of Reflection.

4x 666 S&P 500

 

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/ .

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.

2018 What’s Next?

At the end of the year we begin to formulate ideas about how the next year in investing will transpire. We build scenarios and that helps us invest accordingly. In late 2016 this is what we had to say in our blog about 2017.

Seemingly, every single investing professional that we read or talk has the same expectations for 2017. Experts see a January dip being bought and Wall Street’s best and brightest see 2017 returning a rather staid 5% on average according to Barron’s. We have a funny feeling that isn’t quite how it’s going to work out. When everyone agrees – something else will happen. 

There was no dip to be bought in January and, obviously, the market returned far more than 5%. Since December 2016 in the post Trump election world we have been harping on the idea that we could see a 1987 type of market. While that year brings nightmares to investors you have to remember that before the October crash the market was up 35% on the year. Well, the Dow Jones is now up 35% since Trump was elected while the S&P 500 is up just over 26%.

Our attention in 2018 will be dominated by the draining of liquidity by the world’s central banks. Available research estimates that the G4 balance sheets will peak in Q1 of 2018 and begin to decline. An inflection point will be reached in or around the summer of 2018 when liquidity injections by all four major central banks will end and central banks will begin to drain that liquidity. Since the dawn of the crisis we have felt that any draining of liquidity by central banks would cause markets to shudder. We expect no less in 2018 if central banks should go forward with their plans.

The Fed put strike is falling with rising rates even if markets don’t realize it. As our Head of Global Economics, Ethan Harris, has pointed out, sitting at the lower bound in rates put the Fed in risk-management mode, meaning they had to be ultrasensitive to the risk of making a policy mistake as they had no traditional ammunition to fight a potential downturn. But as the Fed gradually increases rates, and with markets seemingly unconcerned, they will inherently become less sensitive to risk. In other words, the Fed put strike is falling both because the Fed is rebuilding ammunition, and because it recognizes that markets can better stand on their own. Of course surprise inflation remains the real killer as it would effectively handcuff the Fed from providing a high strike put, and will require much higher stress before they can step in. – Bank of America

Investors are seemingly whistling past the graveyard. The market continues to move higher with the underlying belief that any market turbulence will be met by the Federal Reserve’s (The Fed Put) efforts to calm markets. Are they right? As Bank of America is saying investors may be overestimating the extent to which the Federal Reserve can or will seek to contain any market damage.

We still see the possible tax reform passage as a “sell the news” event especially in light of end of the year regulatory funding issues. We are beginning to see some stresses in the system due to that end of the year regulatory funding. Not a major problem but it could cause some ripples. Investors may be looking to push sales and any subsequent gains into 2018. That could cause more selling at the beginning of 2018. This could be a negative unintended consequence of the tax bill passage.

We hope that you will not take us to task for not posting yesterday. We took the day to spend it with our children in the snow. It doesn’t snow that often here in Atlanta, never mind 5 inches of snow, so we take our opportunities when we can.

The market is showing signs of slowing its ascent. It needs a breather although the Santa Claus Rally is just around the corner. We are watching key levels on the charts that the computers might be pointing to. We are also formulating our end of the year letter which will be out in several weeks and we hope to point to more of what we see happening in 2018.

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/ .

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.

Want to Live Longer?

Andrew Scott is a Professor of Economics at the London Business School and is a co- author of The 100-Year Life: Living and Working in an Age of Longevity. I came across his work in an interview from the Council of Foreign Relations and I find his work helpful, not only in planning for client’s retirement but also in looking at the emotional side of retirement. We have had massive transformations in how we long we live our lives and in the quality of our lives since the dawn of the 20th century. Scott’s work shows that a 65 year old today is equivalent to being 51 in 1922! Something to accept going forward is that our lives will be longer and lived with a greater vitality and, in accepting that, working longer needs to be part of our retirement plan. Not necessarily in that same job some of you might dread going to everyday but working at something we love doing. Importantly, Scott’s research found that white collar workers that work longer – live longer. Something to consider.

65 is the equivalent to 51 in 1922, and today’s 78-year-old, in terms of mortality risk, is the equivalent of a 65-year-old. And you think about this longer life expectancy—you know, by some counts, children being born today can expect to live to high 90s, early 100s, if not more. It’s not clear that simply saving more will solve the problem, as we’ve been talking about here.

People never save enough anyway. People are fairly unresponsive to interest rates. So I think if we’re looking at how we finance longer lives, it’s going to have to be working longer.

And of course what is very striking with the data, too, is that effectively blue-collar workers, the earlier they retire the longer they live. White collar workers, the longer they work, the longer they live. I mean, it’s—old age has a very varied distribution across individuals, and some of that is strongly linked to income and particularly education. – Andrew Scott

https://www.cfr.org/event/retirement-challenges-individuals-global-comparison

Some pundits that stand out as perpetual bulls on the market are calling for a respite in 2018. We think that they might be right. The market has been on quite a ride this week and we used the rally this week to lighten up for some of our more aggressive clients. We still see the possible tax reform passage as a “sell the news” event especially in light of end of the year regulatory funding issues and a possible government shutdown dead ahead.

The S&P 500 is now up 13 months in a row and seems to have hit a speed bump. As the technology stocks hit their old highs from 2007 the computer algorithms hit the sell button and began to buy value stocks. Changes in investment positioning may be in store as value may begin to outperform growth. Growth has been the winner for perhaps a bit too long as returns try to revert back to the mean.  The yield curve here in the US is the flattest it has been since 2007 and we worry that it is about to invert and signal a recession. We warned two weeks ago that volatility would return and that it was only a matter of when. Well, it seems like this was the week. We expect more volatility to come as funding pressures increase with the turn of the calendar.

We have talked about the animal spirits being in control and now perhaps it is the computers turn. Keep an eye on key levels. We are watching 2666 on the S&P 500 very closely. The market bottomed at 666 in March of 2008. 4 times 666 is 2664. Close enough for government work. Programmers are humans after all and some numbers jump off the page. Call us crazy but we feel that it is an important hurdle and, make no mistake, the computers are in charge. We are still in it to win it but just a little less and a little less in.

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/ .

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.

Less In

One of our favorite bulls is changing his tone this week as Jim Paulsen of the Leuthold Group seems to be pouring a little cold water on this rally. In his piece titled “No More Juice” Paulsen, a long time bull, says investors should be prepared as central bankers try to wean markets off of the juice (QE). Paulsen has been spot on for years with the market rally since 2008 and when he speaks we listen. We agree with Paulsen and we do not see a market collapse but there is a need to constantly reevaluate and recalibrate where our investment money needs to be in this market.

“As financial markets are weaned off the juice they have been drinking for almost a decade, investors should prepare for a very different bull market in the balance of this recovery,” he said. “Without a chronic injection of financial liquidity, the stock market may struggle more frequently, overall returns are likely to be far lower, and bond yields may customarily rise.”

To be sure, Paulsen is not predicting a market collapse. Instead, he suggests investors will need to shift strategy away from the cyclical U.S.-centric approach that has worked for most of the past 8½ years, due to the likely contraction of money supply compared to nominal GDP growth.

That means value over growth stocks, international over domestic, and inflationary sectors, like energy, materials and industrials, over disinflationary groups like telecom and utilities.

It is our job not to predict but to contingency plan. In order to do that we look to the horizon for what could trip up our investing plans or to find what investments may benefit from changes in the environment. One of biggest worries is China. The yield curve continues to invert in China. For those of you that are new to our blog an inverted yield curve is a sign that a recession may be approaching. A recession in China would have reverberations worldwide. According to FT, Chinese debt has grown from $6T at the beginning of the crisis in 2007 to over $29T today. The government there continues to want reform but needs to proceed with caution to avoid creating a crisis. The Chinese central bank added more reserves to their system this week in one of its biggest injections of 2017 and that helped soothe markets – for now.

In another sign of the imbalances created by central banks and QE it still boggles our minds that European High Yield has less of a yield attached to it than 10 Year US Treasuries. If we have a bubble then it is certainly there. In yet another great piece by John Mauldin, in his Thoughts from the Frontline, he notes the preponderance of negative yielding government bonds. Can you believe that Italy and Spain have short term negative yielding debt? Who would want to own debt from Italy and Spain at negative yields?!  Mauldin also points to Louis Gave and their research suggesting a currency peg could cause a waterfall of problems and they are pointing to Lebanon. It is a very interesting piece. If you don’t get John’s Thoughts From the Frontline, then sign up, it is free.

Market internals continue to deteriorate and that is especially important in light of historically high valuations. The market has entered what seems to be a new pattern of opening lower and rallying back throughout the day. The S&P 500 is up 12 months in a row and has only experienced pullbacks of less than 3% in 2017. The daily range in stocks is the lowest it has been since the 1960’s. The yield curve here in the US is the flattest it has been since 2007 and the curve in China is inverted. Trees cannot grow to the sky and what cannot continue – won’t.  Volatility will return it is only a matter of when. We see the relative strength on the S&P 500 reaching historically overbought levels. When the S&P reaches this level it makes the comparisons very tough. A pullback is warranted in the S&P and when it does the next rally will not be able to surpass these overbought levels. At that time investors will see it as a negative divergence. That is when the market may begin to struggle.

We continue to fret about risk parity and volatility selling. When stocks go down we will look at bond prices. At some point they will both go down in tandem and selling will beget selling. If there is a meltdown, we believe that is where it where we will see it start.

The Warren Buffet of endowment investing is David Swenson from Yale. We were able to watch an hour long interview with the investing legend and have included a link. The interview of Mr. Swenson is from a meeting of the Council on Foreign Relations conducted by former Treasury Secretary Robert Rubin. Here is the money quote.

But when you start out, you were talking about fundamental risks in this world. And when you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling, and makes me wonder if we’re not setting ourselves up for an ’87 or a ’98, or a 2008-2009. David Swenson Chief Investment Officer Yale University

So much to say and so little space this week. Obviously, we are a bit concerned that the rally is a little long in the tooth and investors may have lost respect for the power of markets amid market’s seeming invincibility. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less and a little less in. Tax reform passage could be a sell on the news event and we are, warily, watching the turn of the calendar.  Happy Thanksgiving everyone!! No blog next week as we will be still filling up on leftovers.

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/ .

 

 

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.

Red Flag Warning

Just days after our latest blog post, Bump in The Silk Road, some very interesting comments from central bank governor Zhou Xiaochuan were posted on the central bank’s website. Here is a snippet from Bloomberg.

Latent risks are accumulating, including some that are “hidden, complex, sudden, contagious and hazardous,” even as the overall health of the financial system remains good.

 “High leverage is the ultimate origin of macro financial vulnerability,” wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure. “In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.”

 The latest in a string of pro-deleveraging rhetoric from the PBOC, Zhou’s comments were speculated to have contributed to a rout in Hong Kong shares. They signal policy makers remain committed to the campaign to reduce borrowing levels across China’s economy. Concern that regulators may intensify this drive after last month’s twice-a-decade Communist Party congress helped push yields on 10-year sovereign bonds to a three-year high. 

https://www.bloomberg.com/news/articles/2017-11-04/china-s-zhou-warns-on-mounting-financial-risk-in-rare-commentary

You can feel the pressure building in Washington DC. Republicans are scrambling and their candidate in the Alabama Senate race is in hot water. A loss to the Democrats in the Senate could make passing legislation that much more difficult. That could force Republicans to negotiate more aggressively with the Democrats if they want their tax bill passed. Complicating matters, the government’s current funding agreement expires Dec. 8. While the last agreement just punted to December the next agreement will have a lot more on the line. Also, members of Congress could be distracted by anger emanating from their constituents surrounding health insurance. The window just opened 10 days ago for 2018 and the increases are outrageous. We are hearing it from contacts looking for advice on how to proceed. The open enrollment period ends December 15th. 16 days earlier than last year. The pressure is building. It is going to be an interesting December.

The market seems a bit on edge as everybody knows it can’t just go higher EVERY day. The S&P had its first down week in 8 weeks and even BitCoin went down! Japan was up 23 out of the last 25 days. It broke. Whether the machines broke or investors broke is the question. Investor’s answer was to sell first and ask questions later. It just shows how on edge investors are with the market seemingly up every day everywhere.

We told you things can get weird when the President is out of the country. Saudi Arabia didn’t waste any time announcing their purge. That got oil and oil related stocks hopping. West Texas is at prices it has not seen in 2 years as oil remains in the mid $50 a barrel range with $60 in its sights. High yield bonds have seen huge outflows and that is a red flag warning sign for stocks. The ten year yield bounced higher late in the week to get back to the 2.4% level. The red flag there is its performance in the post Japan mini melt down. Yields jumped higher. Logically, you would think that yields would head lower in a flight to safety. Instead, it appears to be a flight to deleveraging. It is sign that there is too much risk and leverage in the system. If yields and stocks go down together that will be a problem as risk parity funds as they will be forced to cash in some bets. If there is a meltdown that is where it where we will see it start. That boat, that includes the volatility selling crew, is just too crowded.

There are rumors of more indictments when Trump gets back into town. Political uncertainty, rumors of the Saudi king abdicating over the weekend, Japanese flash crashes, and the tax cut bill seems to be DOA for now.  S&P 500 is exhibiting signs of slowing its ascent as the rally is showing some cracks. The bulls could use a time out. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less in.

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/ .

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.

Bump in the (Silk) Road?

With each passing day, week and month we are more in awe of this market. It just keeps plugging along higher and higher. There is no predicting when the momentum will shift so we continue to be invested but just a little less so. The winning strategy is to recalibrate our investing, downshifting in our risk while seeking better risk adjusted returns. It is not our job to prognosticate but to keep an eye on what could upset the apple cart and how to profit from it. Our latest worry is China. China has just completed its most recent 5 Year Congress. Every 5 years the leaders in China get together to elect leadership and formulate the next 5 year plan. Xi Jinping continues to consolidate his power and his grip on one of the great economic engines on the planet. Leading into the congress the leadership there chose stability over change. Now that the congress is over Xi can get back to work. We are looking at China to see if, now that leadership has another 5 years in charge, change is about to come to China. Will China now try to reel in shadow lending in the country and its rampant real estate market? Will they allow a more rapid depreciation in the Yuan? If change comes to China it will reach our shores soon enough as the economic ripples will be felt worldwide.

From Cashin’s Comments this week comes some interesting facts cited by the sharp eyed Bob Pisani from CNBC.

Technology is so strong this month that it accounts for 75% of the gain in the S&P 500, according to Standard & Poors. Without Tech, the S&P would only be up roughly 0.5%. It’s worse than that: five stocks are most of the gain. Big tech this month Facebook up 15.5% Amazon up 12.5% Apple up 8.2% Google up 6.1% Microsoft up 6.0%…Those five stocks accounted for 52% of the gain in the entire S&P 500. What happens if we look at the S&P 500 and equal weight all of the stocks? A very different picture. There’s an ETF for that: the Guggenheim S&P 500 Equal Weight ETF (RSP) is up 1.1 percent for the month. That is exactly half the gain of the regular S&P 500. 

Investor sentiment is always hard to gauge but we keep an eye on it to try and delve where the animal spirits reside. Market pundits have described this rally from 2009 as the most hated rally ever. Most hated maybe because investors have been behind the curve the whole time chasing it ever higher. Also from the NYSE’s resident sage, Arthur Cashin, comes this opinion on market sentiment from Peter Boockvar at the Lindsay Group. Maybe investors have now caught the tiger by the tail. 

This boat is now standing room only. Investors Intelligence said Bulls rose 1.2 pts to 63.5, that is the highest in about 30 years. It peaked at 65 in 1987. Bears fell to 14.4 from 15.1 and that is the lowest since May 2015. The spread between the two of 49.1, is just below the 1987 peak of 50.5. I’ve said this before, when sentiment gets this stretched, markets tend to consolidate its gains.  Given those figures, it’s tough to claim that this is the “most hated rally in history”.

The market has finished higher ten months in a row!! In a era of monetary extremes this is one for the ages. We have never had a year that the market closed higher for the first ten months of the year. Never. By way of Deutsche Bank’s Jim Reid, we see that the record is 12 months in a row set in 1949-1950 and 1935-1936. We grow concerned that the rally is growing even more stretched and more narrow in its rise. The techs are in charge as the Big Five accounted for half of the gains last month. A rally that grows more and more narrow is not a healthy market. S&P 500 shows signs of slowing its ascent. The market could use a consolidation period. It makes for a much stronger foundation. The bulls are still in control but with the President out of the country we tend to get a little nervous. We still see 2600 as logical resistance for now. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less in.

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/ .

 

 

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.

My Name is Mario and…

We have talked about the rise in central bank balance sheets and how those balance sheets may be THE most important metric when investing in this era. The European Central Bank (ECB) made an announcement this week and it seems that central bankers while promising to cut back and reduce balance sheets are already hedging their bets. The ECB, while slated to end their form of QE in December, announced that they will continue to use until September of 2018. But they are promising to cut back their monthly usage in half. Like an addict that says that they will quit just not right now. This form of monetary heroin is responsible for the rise in asset prices and it is causing distortions like European High Yield yielding less than the US 10 year. This is the height of lunacy. We are not happy being right. It is our job to make money so while central bankers print and buy assets we stay at the party. The bigger question is will central bankers ever stop printing?  While we see that the G-4 central bank balance sheets are slated to stop growing in 2018 we question the will of central banks to stop the monetary heroin.

We are stuck in our thesis on the concept of the “Fed Put” and how that is going to evolve and effect asset prices. One of the drivers of this relentless march higher is the idea to BTFD. Buy the Dip. Every dip in stock prices is bought because you don’t’ have to worry because if there is a real crisis the central banks will come in and back stop the market. So you find yourself asking, will prices ever go down? That alone has us nervous. If something cannot continue forever it won’t. The market will go down at some point. It always does and it is never different this time.

Tech stocks had a phenomenal week as we saw Amazon up 13% and Intel up 7% on Friday alone. It is starting to feel like a mania as the animal spirits have taken over. The broader market did show some technical signs of weakness. A warning shot across the bow perhaps? We still think that a tax plan passage is a sell the news event.

This is a one way market and investors need to recognize this and take steps to manage risk. Recalibrate. Market structure is responsible. The market is flawed in its design as its automated structure puts the momentum players, the market makers and algorithms in control. While it is pleasurable to see it go up every day it will be much quicker and painful when the market goes down in a one way fashion. For every action there is an equal and opposite reaction.

The ten year Treasury broke through 2.4% and closed the week at 2.416%. We are looking for a new range between 2.4% and 2.6%. Above 2.6% and the warning lights will come on. The bulls are still firmly in control. 2600 on the S&P 500 is the next logical stop. Much as 666 loomed large in early 2009 the number 2666 now looms large for the S&P 500 and is less than 4% away from current levels. Wall Street and investors are a superstitious lot. The animal spirits are unpredictable and in control. Gotta be in it to win it but, maybe just a little less in.

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/ .