Tick Tock

After one of the slowest starts to a year in the last 100 years market volatility is coming back. Just as everyone is about to head off to the beach things are getting interesting. Why do Federal Reserve officials keep trying to change policy in the summer? It is a very illiquid time of the year and made only more so by the changes in Dodd Frank. This illiquidity and the looming Presidential election are going to complicate things for the Federal Reserve.

It is worth reminding you of our last post and the ideas of investing in a central bank dominated world. As long as central banks maintain current policy asset prices will continue to climb. A slow down in balance sheet growth would bring slower asset price growth much as it has in the United States since last October. Investors are nervous but policy is still accommodating. History has shown that markets do not turn on a dime on the first rate hike by the Federal Reserve. It is the second rate hike that begins to slow markets. Rest assured Fed officials have made it clear that they will catch markets when they fall. We may be in a period of subdued returns as markets show signs of slowing their ascent but not turning lower. We are long but have our guard up.

Bond yields have begun to move higher in the last month. Could the market be trying to force the Fed’s hand into raising rates? The Fed will not want to lose control of the bond market. As David Stockman, former Director of the Office of Management and Budget for the Reagan White House said last month in his blog, the market is in a game of chicken with the Fed. The Fed will want to set the tone for the bond market but may be hampered by the looming 2016 Presidential election. If the Fed raises rates in a weak economy they could be blamed for triggering a recession in an election year. Remember that Congress has oversight of the Federal Reserve. The Federal Reserve is not going to want to be blamed for a recession and its influence on the election. We look for them to become more opaque in their guidance. Will the Fed have the courage to lead and raise rates in 2016? We have our doubts.

What is going on here plain and simple is a one-sided game of chicken. The robo-traders and hedge fund buccaneers on Wall Street press the market higher on virtually no volume or conviction whenever macro-economic weakness presents itself, virtually daring the Fed to maintain is ultra-accommodative stance still longer. – David Stockman

http://davidstockmanscontracorner.com/chop-chop-choppin-at-the-feds-front-door/

Amazingly, the market is still stuck in an increasingly tighter range and the tension continues to build. The broader range of the S&P 500 is 2040 -2120. The 2080 area and the 100 Day Moving Average will be watched closely. Markets tend to break out the way that they came in but this one had a false breakout to the upside in the last couple of weeks. That increases the odds of a break down. The bulls will look to 2080 on the S&P 500 to hold and if the S&P breaks through there then key support will be the bottom end of the broader range with 2040 and the all important 200 day moving average as support. A sustained break below that area would bring out more sellers but until then the prevailing trend is higher. While metrics have the market at historically high valuations we don’t see asset prices turning lower until central bank policy changes.

Is this the “new normal boom”? Robert Shiller, Nobel laureate from Yale University has coined the phrase the “new normal boom”. This is not your father’s bull market based on an ever increasing greed and exuberance. As this market has edged higher so has the anxiety associated with it. We are long but increasingly nervous.

“I call this the ‘new normal’ boom — it’s a funny boom in asset prices because it’s driven not by the usual exuberance but by an anxiety.Robert Shiller

http://www.newsmax.com/Finance/StreetTalk/robert-shiller-bubbles-economy-federal-reserve/2015/06/01/id/647999/

We have had low durations in our bond holdings and that has helped. Keep your durations low as the market finds its levels and the market adjusts. We suspect that any move higher in interest rates by the Fed may not be long in nature.  Stocks will continue to be subdued until they are not. Things could get hot this summer. Watch your levels. The 200 day moving average is the fulcrum between a bull market and a bear market.

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.

Tension is Building and Heads Roll in Saudi Arabia

A recovery in China, the world’s second-biggest economy, would influence securities and commodities prices around the globe, said Stanley Druckenmiller. For instance, it would send German government bond prices lower, boost European exporters and lift the price of oil. Stanley Druckenmiller – BLOOMBERG 4/15/2015

I have included a link the whole Druckenmiller interview with Bloomberg. It is 45 minutes long but well worth the time. Druckenmiller is one of the greatest investors of our generation and he touches on topics including Central Bank policy, oil prices and the economy in China. Druckenmiller obviously believes that a recovery in China would have reverberations worldwide.

http://www.bloomberg.com/news/articles/2015-04-15/druckenmiller-bets-on-market-surprise-with-china-boom-oil-rise

Central banks continue to dominate the conversation. Central banks in the US, Japan and Europe are buying up bond issuance and inflating asset prices. As long as central banks maintain current policy asset prices will continue to climb. A slow down in balance sheet growth would bring slower asset price growth much as it has in the United States since last October. Investors are nervous but policy is still accommodating. History has shown that markets do not turn on a dime on the first rate hike by the Federal Reserve. It is the second rate hike that begins to slow markets. Rest assured Fed officials have made it clear that they will catch markets when they fall. We may be in a period of subdued returns as markets show signs of slowing their ascent but not turning lower. We are long but have our guard up.

Market is still stuck in an increasingly tighter range and the tension is building. The range in the S&P 500 is now 2040 -2120. Markets tend to break out the way that they came in. The odds are that it breaks out to the upside with 2200 as a target. The volume has been increasing on the downside of late but the market is holding its levels and its all important 200 day moving average. A sustained break below that area would bring out sellers but until then the trend is higher. While metrics have the market at historically high valuations we don’t see asset prices turning lower until central bank policy changes.

In our last blog post we told you to keep an eye on Saudi Arabian policies affecting the price of oil. Saudi Arabia replaced the head of its state-run oil company this week. We think that oil prices may benefit. Keep an eye on Saudi Arabia. Druckenmiller thinks China is recovering. We agree with Druckenmiller that the US Dollar will continue its recent trend and that may be a headwind for commodities but a recovery in China will take precedence. A Chinese recovery will benefit all commodities including oil, copper and gold.

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.

Cash

Market got the chills this week from a better than expected jobs report. That report may be the excuse that is needed for the Federal Reserve to move on rates. The market has been in a sideways consolidation pattern since the Fed ended QE back in October of 2014. We are not surprised as we surmised that equities would at least slow their ascent without the aid of the FOMC and easy money. The reinvestment of dividends by the Fed has enabled the market to maintain its holding pattern. If the FOMC plans to raise rates in June then very soon they should announce that they will halt reinvestment of dividends that they receive. The jobs reports on Friday made that possibility all too real for investors. While the market’s technicals look fine here markets may pull back to 2000 on the S&P 500 and take another look. What was so disturbing about Friday’s action was that no asset class was spared. Gold. Bonds. Stocks. Everyone took their lumps. Cash was king on Friday. A decent stash of cash may be the thing for now. Caution lights are on but no alarm bells until the S&P 500 breaks 2000.

There were some thoughtful discussions around the street this week on the subject of corporate buybacks. Corporations announced over $104 billion in buybacks last month according to Trim Tabs. This is the most announced buybacks since Trim Tabs started tracking the data in 1995 and it was double the February 2014 number. While the idea of a corporation buying back its own stock is a tailwind for investors, corporations tend not to be the best stewards of capital in that regard. Understand that there is an inherent conflict on interest in a CEO buying back his own stock. It increases Earnings per Share (EPS) and helps elevate the company’s stock price. This is a top priority for any CEO who is expected to keep a very large part of his/her net worth and compensation in said stock. While a buyback makes sense if a stock in undervalued it is harmful if a company pays too high a price for its investment. What seems a lifetime ago I was the Specialist in Ford Motor Company. Ford had a very large repurchase plan. On a particularly bullish day in the stock the company complained that they were not buying enough stock. The stock was up $5! Why would the company need to buy stock? Within six months Ford Motor had a rollover problem with its Explorer and the company announced a suspension of its buyback program. Companies tend to buy lots high and nothing low. Arthur Cashin had this to say on buybacks earlier this week.

Records show that companies have bought over $2 trillion of their own shares since the low of 2009.  They are on a pace to spend about 95% of their earnings on buybacks and dividends.  No wonder we’re at new highs.

Oil has bounced but not as high as most would like. The move in oil from its highs last summer is nothing short of a crash. More blood may need to be spilled in that sector as bankruptcies are announced which will decrease production and eventually help raise prices. Keep an eye on Saudi Arabian policies and geopolitical events in Russia for clues on the price of oil. Market has been in a range between 1975 and 2100 on the S&P 500 since late October since QE ended. Could the recent move above 2100 been a false breakout and have investors looking for cover? Can markets handle the Fed halting reinvestment and raising rates? 2000 is support for now. All eyes will be on 2000 for clues.

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.

Investing in The Oil Patch

If there is one topic on clients minds it does seem to be the price of oil and investing in oil related stocks. We are cautious here. It seems that the volatility in this space is only beginning. Shale producers are the swing producers in the oil complex at this juncture. As a group shale producers are more nimble than other players in the oil complex. If shale producers are the swing producers then we may be in for a period of volatile energy prices. Shale producers in the United States will be more apt to bring on production and cut production swiftly. Larger national producers like Saudi Arabia and Mexico are less nimble in their approach and the larger national operations have dominated this landscape for decades. If the shale producers are in fact the swing producers then oil prices may be less stable going forward. That is if the shale producers survive the latest oil glut.

As for oil prices right now, in my trading experience bounces like the one we have seen off of the $40 level are usually seen in bear markets. Very sharp and very severe while usually short in duration. I am bullish in the longer term for investing in the oil complex as I have been for most of my career. The oil majors are diversified across the energy complex as well as internationally. They are large companies with solid balance sheets and pay larger than average dividends. As a long term investor what’s not to like? Time will tell but I think it will behoove one to be patient investing further in the oil patch.

By way of Arthur Cashin comes a very interesting perspective on the latest oil volatility and drop in prices. His good friend Jim Brown of Option Investor has an interesting thesis on crude storage capacity. Here is what he had to say this week.

 Oil inventories are at 80 year highs and global storage is filling up fast. Once available storage is at capacity the impact to oil prices is going to be dramatic. Crude inventories in the U.S. have risen over 30 million barrels in the last four weeks to 413 million barrels. That is an 8% rise in inventories in just four weeks and this can’t continue forever. According to the EIA the U.S. has 373 million barrels of storage capacity in various tank farms plus 70 million barrels at the Cushing Oklahoma futures delivery hub. Refineries have another 148 million barrels of capacity.

 Inventories normally rise until early May so there may be some trouble ahead.

 The world’s largest oil trading company Vitol said they expect a “dramatic build in oil inventories over the next few months.” If oil builds as we expect we could see a dramatic drop in prices. Most oil analysts believe the +20% spike in crude over the last two weeks was short covering and a new move lower is ahead.

Once land storage and tanker storage nears capacity, oil prices could turn ultra-volatile. 

Negative interest rates seem to be all the rage amongst central banks. It is a race to the bottom for currencies.  Denmark, Sweden, Switzerland and the Euro Group all have negative interest rates.  In Denmark it is being reported that you can get a negative interest rate mortgage. The bank will pay you to take out a mortgage! No danger of a real estate bubble there.

The market broke out above the range the S&P 500 has been in since December. That put the bears and underinvested on the defensive forcing buyers into the market.  Negative news out of Europe on the Greek situation could knock bulls back but the range breakout has to be respected. Greece is down 4% overnight on rumors of No Deal. One little touched upon thesis for the equity markets here in the United States is that of a melt up. High equity valuations have major investors underinvested and expecting a pullback in pricing. A major run higher could be in store if the United States is perceived to be a safe haven with its strong currency and positive interest rates while the underinvested are forced to chase the market higher.  Investing is contingency planning. Consider all of the possibilities. May you live in interesting times.

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.

Bang!

2015 has certainly started with a bang. Seemingly, every day of trading has seen the range of the Dow Jones Industrials measured in hundreds of points.  It has become obvious to all that since the Federal Open Market Committee (FOMC) ended its purchases under Quantitative Easing (QE) back in October that Central Bank policy had the effect of suppressing volatility and supporting asset prices. We had the expectation that with the end of QE that bond prices would rally and stock prices would at least stall in their ascent and perhaps move lower. That has been the case so far in 2015.

Worrisome is the increase in the intensity of currency wars being promulgated by the various central banks around the world. Central banks are playing a game of beggar thy neighbor and wish to reduce their currency below their trading partners. All is well and good and may in fact help those first actors but watch out what comes next.  Trade wars. When those losing the currency game become trade warriors and enact tariffs and embargoes we will all be brushing up on our Smoot Hawley references. For those of you that do not remember. The Smoot Hawley Tariff Act of 1930 is what is blamed for really setting the Great Depression in stone. Keep an eye out for Smoot Hawley’s around the world. Trade wars may be next.

While the US Dollar is soaring to ever greater heights the price of Gold is rallying as well. Usually when the US Dollar is going higher Gold struggles as it is priced in US Dollars. If you live in Russia or China it takes more Rubles or Yuan to buy the same amount of gold. Gold is moving higher in the face of a rising US Dollar. Why is that? The world is trending towards deflation. Why is Gold rising? The currency wars we referenced. Gold is being seen as a currency. A currency that you cannot debase. It is a store of value. If you are in Russia and the Ruble is getting badly damaged move your money into NYC real estate or gold. A store of value. Keep your eyes on Gold.

Equity prices have been stuck in a trading range between 1980 and 2080 on the S&P 500 since early December. Most of the time markets tend to break out of those ranges the way that they came in. It is a 60/40 proposition that it breaks higher. The end of QE with margin debt at all time highs and sky-high equity valuations have the bulls on edge. The trend of higher asset prices since 2009 has any bears that are left standing on edge. High yield bonds may also be signaling lower equity prices. Anecdotally, it has gotten slightly easier to make money on the short side of this market lately. Watch the trading range. The 200 Day Moving Average on the S&P 500 of 1978 will be closely watched for support. Trend following bulls may move to the sidelines on any breach. Federal Reserve officials have been protecting the lower end of the range with public comments. Bears will cave quickly on any move above 2080. Watch for the break out.

2015 is looking like it is going to be the Year of Volatility. The US Dollar is very overextended to the upside and that boat is very crowded on the long side of the trade. Currency moves tend to stay in trend for extended periods. Be careful. Everyone thinks that the Dollar is headed higher. That usually spells trouble. Stay on your toes. Jeffrey Gundlach of Double Line Funds has said that if oil goes to $40 the US 10 Year may move to 1%. So far in 2015 he has been spot on.  Right now the US 10 Year is at 1.64%. The German 10 Year is at 0.34%. That makes 1.64% look downright enticing.

We sent out our Quarterly Letter earlier this month which takes a more in-depth look at our views on the investing landscape for 2015. If you are interested in receiving it just drop us a line at terry@blackthornasset.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 .

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.

Elevator or the Stairs??

Small caps have been our roadmap as we continue to assess the risk/reward conundrum that investing in a central bank dominated world presents. Small caps led us to see the shortcomings in the market before its brief fall in mid October which allowed us to use some dry powder and positively influence our returns this quarter. While the selloff was brief and somewhat violent the aftermath has been anything but. A long slow grind higher has all those who missed the selloff regretting their reticence. This bull market has been built on low volatility interspersed with infrequent violent selloffs. The market has a way of taking the stairs up and the elevator down. Our vigilance to any signs of volatility is of paramount importance and will continue to portend downside moves.

Our antenna is raised to any talk of increased bands of volatility in markets, of letting markets run. In the Federal Open Market Committee (FOMC) October minutes there is one paragraph that stands out for us and that is its mention of volatility. When markets began to rally in mid October its rally can traced to a Federal Reserve official commenting that it would be possible to delay the end of its Quantitative Easing (QE) program. It is evident in the committee minutes that it does not want markets to get used to officials jawboning markets when they become volatile. The emphasis is ours in the following statement but it does appear that the committee is willing to expand the bands of volatility. Stairs up and elevator down.

…members considered the advantages and disadvantages of adding language to the statement to acknowledge recent developments in financial markets. On the one hand, including a reference would show that the Committee was monitoring financial developments while also providing an opportunity to note that financial conditions remained highly supportive of growth. On the other hand, including a reference risked the possibility of suggesting greater concern on the part of the Committee than was actually the case, perhaps leading to the misimpression that monetary policy was likely to respond to increases in volatility. In the end, the Committee decided not to include such a reference. 

Minutes of the Federal Open Market Committee October 28-29, 2014

http://www.federalreserve.gov/monetarypolicy/fomcminutes20141029.htm

Bill Gross of Janus is out with his latest missive and in it he complains of Central Banks trying to cure this debt crisis with more debt and the consequences of such. He is one of several high profile investors calling for low future investing returns and the need for investors to have cash on hand.

Markets are reaching the point of low return and diminishing liquidity. Investors may want to begin to take some chips off the table: raise asset quality, reduce duration, and prepare for at least a halt of asset appreciation engineered upon a false central bank premise of artificial yields, QE and the trickling down of faux wealth to the working class. If the nursery rhyme theme is apropos to the future, as well as the past, investors should remember that while “Jack and Jill went up the hill,” that “Jack fell down, broke his crown, and Jill came tumbling after.

Bill Gross Janus 12/04/2014

https://www.janus.com/bill-gross-investment-outlook

One of our favorite investment letters to read is Jeremy Grantham as he takes a quantitative approach to value investing. His study of bubbles in markets has led him and his team to conclude that bubble territory is 2250 on the S&P 500. Here are his comments from his latest letter.

Nevertheless, despite my nervousness I am still a believer that the Fed will engineer a fully-fledged bubble (S&P 500 over 2250) before a very serious decline.

My personal fond hope and expectation is still for a market that runs deep into bubble territory (which starts, as mentioned earlier, at 2250 on the S&P 500 on our data) before crashing as it always does. Hopefully by then, but depending on what the rest of the world’s equities do, our holdings of global equities will be down to 20% or less. Usually the bubble excitement – which seems inevitably to be led by U.S. markets – starts about now, entering the sweet spot of the Presidential Cycle’s year three, but occasionally, as you have probably discovered the hard way already, history can be a snare and not a help.

http://www.gmo.com/websitecontent/GMO_QtlyLetter_3Q14_full.pdf

Investors have reason to be excited. From a seasonal perspective this period of time from November 2014 to March of 2015 would represent, historically, the best period of returns. Market players may have a hard time resisting a rise in stock prices as the stars are aligned for further gains in this cycle if history and seasonality is any guide. It could however lead to a buying panic as equity valuations become further stretched and investor’s party like its 1999.

For the last few years the time to take profits has been when volatility shows up. When volatility calms down it is time to ride markets slow grind higher. Keep both hands on the wheel. When volatility rises take cover. When the storm passes you can advance. Volatility is the key. Higher volatility equals lower stocks.

Watch the Russell 2000 for clues to equity prices. Lower oil. Is it a supply issue or a demand issue? We think it both. It could lead to more geopolitical issues.

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.

Broken Clocks and Sandcastles

Many of you have been anxious to hear how we feel things are unfolding. While we are busy this week writing our quarterly letter we thought that given the volatility and pain of this week we would write you a small note. Like a broken clock that is right twice a day we have been in tune with the market of late. We felt that the wind down of QE in October would bring volatility to the markets that the Fed, while not welcoming it, would ALLOW volatility to proceed. This bull market has been built on the back of dullness. Most of the returns garnered since the lows in 2009 have been when volatility was low. High volatility has been seen only during pullbacks in the market. A lack of volatility breeds complacency and risk taking. Stability can breed instability. Like a child’s pile of sand at the beach that grows ever higher it only takes one additional grain of sand to knock down an entire side and you don’t know which grain of sand that will be. The Federal Reserve knows this and, I feel, senses the need to bring back volatility and a respect for risk. Not to mention the fact that they may be out of bullets.

As a reminder we had this to say in our blog post back titled Riding the Waves back in July.

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. https://terencereilly.wordpress.com/2014/07/07/riding-the-waves/

The bearish thesis that we laid out certainly showed itself this week as the S&P 500 had its worst week in two years. Our key level on the Russell 2000 ETF (IWM) had been a break of 108 which would lead the bears to make a push down to 96. We closed Friday at 104.74. (Remember these are not predictions just food for thought. Broken clocks you know.) The market is oversold at this point and due for a bounce. October’s Ghosts are out and about as fear is rising. Tough Thursday’s in October which are followed by dull Fridays have led to historic Monday’s. Tuesday could be a chance for the bulls to push back as Turnaround Tuesday comes back into vogue.  We will move our stop loss a little higher as a move above 114 on IWM would mean that the bulls are back in charge.

We are still very concerned about the Fed’s exit from QE while seemingly the rest of the world’s central banks are ramping up their money printing efforts. Currency wars are all the rage as it is a race to the bottom. If your currency is lower than your neighbors you will sell more stuff. Japan, China and Europe are seemingly in economic decline while Russia may be in the midst of a currency crisis. Not a great feeling when profit margins in the US are at all time highs with overpriced markets and highly margined accounts.

Keep an eye on the Russian Ruble. Small caps are the road map. Monday morning may be very interesting if history is our guide.

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.

October Ghosts?

For the last few years the time to take profits has been when volatility shows up. When volatility calms down it is time to ride markets slow grind higher. We have been warning for months that volatility would rise as the Federal Reserve exits its QE policy this month. We had this to say in our blog post back titled Riding the Waves back in July.

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. https://terencereilly.wordpress.com/2014/07/07/riding-the-waves/

Our bearish thesis has been playing out over the last two weeks. Bears have pushed the bulls back as the Russell 2000 ETF (IWM) has reached an oversold level and support at 110. We have postured that the failure of small caps to confirm the new highs in large caps was precipitating a period of higher volatility and a move to the downside in equities. Friday’s oversold bounce helped the bulls take back some ground but I believe that the bears are still in charge. For now we are in a range between 110 and 118 on the Russell 2000 ETF (IWM). A close below 108 on the IWM will auger in a very quick move down to 96. That would be a move of 13.5% lower from current levels. Large caps will not fall by as much but it could change the trend of the market and that could last for months. A move above 118 on IWM is our stop loss and that would mean that the bulls are back in charge.

Beyond the recent volatility and downdraft in equities we think that the major story is in Foreign Exchange volatility. The changes in Central Bank policy around the world are causing more than merely ripples on the pond as central bank policy is getting investors all wet. The US Dollar has roared higher the last several weeks as the US Federal Reserve tries to get out of the money printing business while Europe and Japan ramp up their efforts. Mohamed El Erian former head of PIMCO and the Chief Investing Officer of the Harvard Endowment had this to say when recently queried on the subject.

Q: Meanwhile, the dollar has been soaring.

A: This is an issue that’s completely off the radar screen that should be of interest to all investors. I warned about this much earlier that at some point volatility will return to the currency markets. And it’s returning for three very valid reasons.

First, the U.S. is on a different economic track than Europe and Japan. The U.S. isn’t growing as much as we’d like it, but it’s growing and continues to heal. Japan and Europe are going the other way.

Second, policy is starting to diverge. The ECB is stepping harder on the stimulus accelerator while the Fed is slowly easing off the accelerator.

Third, the geopolitical tensions affect Europe a lot more than the U.S. So what we have seen is a major move in the dollar versus both the yen and the euro. This is key because it means the return of volatility in the foreign exchange market can undermine central banks’ effectiveness in limiting volatility elsewhere, which is one of their objectives. (Emphasis mine.)

Here is the link to the full interview that appeared in USA Today. http://www.usatoday.com/story/money/business/2014/09/13/bartiromo-mohamed-el-ehrian-scotland-vote-economy-pimco/15507249/

How to proceed? I came across this assessment of current markets by Josh Peters over at Morningstar. Josh holds his CFA and writes the Morningstar Dividend Investor which I find a very worthwhile read.

My chief strategy along these lines is to exercise patience, particularly while being compensated with yields that are well ahead of the market average. A speculative strategy that goes out of style might never come back, but when growing, moat-protected, soundly financed firms fall out of favor, they’re bound to rotate back into favor eventually. To let a prolonged period of underperformance from solid businesses drive us to chase bigger returns elsewhere would be a terrible mistake. Far better to wait things out. – Josh Peters CFA Director of Fixed Income/Equity

A rising dollar is going to hurt multinationals profits and put a damper on commodity prices. Watch the US Dollar. Watch the Russell 2000 for clues to equity prices. October is always a nervous month for investors. Hang on. It could be a bumpy ride as the FOMC exits QE.

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.

Euphoria and Scrambled F-15’s

Unresponsive plane. Scrambled F-15’s. Something went horribly wrong. Those were the headlines last week when a single prop plane suffered a sudden and catastrophic loss of cabin pressure. We have a colleague who is a very astute investor with a lifelong connection to flying, the aviation industry and the investigation of plane crashes. According to our colleague, a plane flying at 31,000 feet needs to be pressurized in order to protect it from the outside elements. A cabin that loses pressure can quickly turn into a death trap. Typical procedure when faced with a loss of pressurization would be to declare an emergency and reduce your altitude to 20,000 while donning an oxygen mask. The pilot’s other choice would be to declare an emergency and proceed to 10,000 where he/she could breathe without assistance. It may be speculation at this point but it appears that last week a pilot with over 20 years experience lost pressurization over the eastern United States and F-15 fighter jets were scrambled in response. According to air traffic controller transcripts the pilot stated “We have an indication that is not correct on the plane”. He proceeded to reduce his altitude to 28,000 feet.

“Not correct on the plane.” As humans we have a tendency to go with our gut or ignore warnings signals because all looks or seems fine. Why didn’t a pilot with 20 years experience declare an emergency? Why didn’t he quickly descend to 20,000 feet and put on his oxygen mask or just go straight to 10,000 and avoid danger completely as his signals were indicating? One of the symptoms of not receiving enough oxygen is a feeling of euphoria. Was it pilot error due to the loss of oxygen or was he simply ignoring the indicator light? As humans we tend to ignore things that get in our way. We may not want to come down from 31,000 feet because the air is thinner and we will get to our destination faster. Managing your investments is like being a pilot. It is about managing risks to get to your destination.

Being long the market seems to be bringing feelings of euphoria as the market marches ever higher. All systems go. Let’s not let the feelings of euphoria take over us. Let’s make sure we are paying attention to our warning indicators. The indicator lights are flashing red in the markets. If we come down from 31,000 feet we may get to our investing destination a little slower but at least we will still get there. Let’s make sure we get to our investing destination. Is it time to come down to 20,000 feet and put our oxygen mask on?

This is what we had to say in our last blog post and not much has changed on the technical front. The Russell 2000 has moved below some of its moving averages and that has us leaning even more towards our bearish thesis. A move above 118 on IWM is our stop loss and that would mean that the bulls are back in charge.

 The chart I am watching is the Small CAP Reversal chart I attached below. It is a textbook reversal pattern. Having said that, nothing right now that is happening from a monetary perspective is in the textbook. Watch the Russell 2000  (IWM). If it closes below 108 it should go to 96 very quickly. That is a 17% drop from current levels. Large caps will not fall by as much but it could change the trend of the market and that could last for months. 

 Hope this helps. If you can keep your head while…

 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.

Published in: on September 13, 2014 at 8:47 am  Leave a Comment  
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Do You Remember? Dancing in September

September. A month when thoughts turn to returning to school and the weather cools as investors and traders return from the beach. The relaxation of summer is quickly replaced by the feelings of anxiety. There are no months that strike fear and anxiety in the hearts of investors more than September and October. This year will be no different. The two worst performing months on the calendar are the aforementioned months. The reminder of September 11th for traders who were there only serves to heighten the anxiety felt. As you know we find that the seasonality of markets to be a reliable source of alpha as human beings refuse to change their well worn patterns. From Arthur Cashin and Jason Goepfert comes some fresh research on the where we stand on the upcoming seasonality and what next month may hold in store.

 1.Volume on the NYSE has been well below average, which is not unusual for a pre-holiday week. When stocks hit new highs on below-average volume, they tend to under-perform a bit longer-term, relative to when they hit new highs on above-average volume.

 2.If the S&P 500 closed August with a gain of 3% or more, then it added to its gains in September 36% of the time. If it also closed at a 12-month high in August, then September was positive only 1 out of 12 times, averaging -2.6%. If August closed with a gain of 1% or more, and a 12-month high, then September was positive only 3 out of 19 times, averaging -1.6%. All data since 1928. – Jason Goepfert Sundial Capital Research

As you know we have felt that the bond market still had legs in its rally in 2014. (2015 may be a different story.) Also by way of Arthur Cashin are the following notes from Barry Habib who has nailed the bond market and its course so far in 2014.

 Here are some additional reasons to support a continuing decline in US yields.  Foreign investors, especially those in Europe, will likely be attracted to investing in US Treasuries.  Not just because of the obvious and wide spread between the US 10-year Note and German 10-year Bund.  There is an added currency play which could greatly improve the returns.  As QE3 comes to a close, we have already seen the Dollar strengthen against the Euro.  This trend should continue as tapering is finalized.  Adding to the Dollar strength against the Euro is the strengthening US economy against the sluggish Eurozone. – Barry Habib

Arthur goes on to mention that another reason to be long US Treasuries is because everyone else is seemingly on the other side of that trade and short US Treasuries. There is massive money short US Treasuries which is a bet that Treasuries will lose their value and have prices head lower. For most of 2014 that trade has been a loser. The thought being that with the Fed ready to start raising rates it would be a no brainer that Treasuries would lose value. Not so much.

Keep your eyes on Us Treasuries as any geopolitical rumblings or deflation in Europe may push more money into bonds. We will find out in the next two months as to how much the Federal Reserve’s QE policy has held up stock prices. Those purchases are being eliminated in the next 60 days. This is where the rubber meets the road. It is ironic that the Fed policy is being withdrawn at the worst point seasonally for stocks. The anxiety level of investors for September and October will only be heightened. Gold keeps trying to break out but is being held back.  As for stocks here is a note we sent to a friend this week.

 Just for kicks – the high in 1987 was put in the day after Labor Day. 

 The chart I am watching is the Small CAP Reversal chart I attached below. It is a textbook reversal pattern. Having said that, nothing right now that is happening from a monetary perspective is in the textbook. Watch the Russell 2000  (IWM). If it closes below 108 it should go to 96 very quickly. That is a 17% drop from current levels. Large caps will not fall by as much but it could change the trend of the market and that could last for months. 

 Now the good part. No problems. Only opportunities. Take a look at the 2nd chart – Dow Jones Bull Bear Cycles. The last two Bear cycles lasted 17 & 18 years. We are 14 years into the current Bear Cycle. Take a look at the 1970’s bear cycle. I expect much the same to happen here. The last major move down is expected by investors and therefore should be much shallower than the previous moves in the Bear Cycle. Investors are prepared this time. (The old – they are not going to get me again!) Granted monetary policy is a bit experimental and anything can happen. I just think a major dip this late into a Bear Cycle will need to be bought. 

 Hope this helps. If you can keep your head while…

 bigcharts.com 

 Small Cap Reversal August 2014

 Dow Jones Bull Bear Cycle

 

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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