Santa’s Sleigh Bells

The media and blogosphere have lit up with their prognostications as to whether Santa Claus will make his appearance on Wall Street this year. One point of order is to note that the traditional Santa Claus Rally is not the entire month of December. It is only the last 5 trading days of the year and the first two of the New Year. But the gain is only on the order of 1.5%. The market was up 2% yesterday! What we really need to be on the watch for is if Santa does not come. The old saying goes, “If Santa Claus Should Fail To Call, Bears May come To Broad and Wall”. If Santa does not come as ordered the market may be telling you that it is headed for trouble.

But even if it does get into trouble won’t the Fed just bail us out of it? In an interview yesterday Mario Draghi, Head of the ECB, stated as much. When asked by Mervyn King, former Governor of the Bank of England, whether his speech on Friday in NY was meant to counteract Thursday’s market disappointment he responded “of course”.

Federal Reserve officials may follow Draghi’s lead in 2016 as they begin to try and get off of zero interest rates. According to our good friend Arthur Cashin, the last time that the Fed raised interest rates with the ISM below a reading of 50 was in 1981. (A reading of below 50 on that report indicates that we have an economy that is contracting rather than expanding.) In 1981 inflation was running at over 10%. The market fell 23% over the next year.

Here is what we are watching in relation to the Federal Reserve hiking interest rates. The first hike generally does not hurt stock prices. It is the second and the third. In late 1936 we were still experiencing the effects of the Great Depression. Inflation began to tick higher and the stock market was also headed higher. Officials began to think that raising rates was appropriate. Unfortunately, they were tightening monetary policy while other countries we still busy trying to devalue their currencies. Demand for dollars increased sharply.  Sound familiar? Stocks bottomed out in 1938 down almost 50% from their highs. Not saying it is going to happen again but history does have a tendency to rhyme.

Bill Gross, known as the Bond King, had this to say this week on risk and asset prices.

Timing is the key because as gamblers know there isn’t an endless stream of Martingale chips – even for central bankers acting in unison. One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down. But when? When does Martingale meet its inevitable fate? I really don’t know; I’m just certain it will. Doesn’t help you much, does it. Except to argue that much like time is relative to the speed of light, the faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets. I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money. Even Martingale casinos eventually fail. They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close.

We have seen an upswing in volatility here in the 4th Quarter of 2015. We believe that portends a higher range of volatility across asset classes in 2016. While we believe it is going to be a positive year it will not be without its bumps and bruises. Tactical allocation decisions may be the key to increasing your gains or even perhaps having gains at all.

While we are cognizant of low returns in this environment we still think it prudent to have some cash on the sidelines. A policy error could have severe consequences for asset prices. The United States may have worked their way out of this crisis and repaired its balance sheet but what about the rest of the world? A policy act by the Federal Reserve could send the tide out and we may find that some countries have been swimming naked. In the event of large market swings in 2016 the FOMC may be forced to bring more easy money in the form of QE. We think that, for investors, 2016 is going to be anything but easy money.

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.

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