The End of the World

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

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

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

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

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

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

 

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

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

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

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

 

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

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

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

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

What’s Next in 2016?

Summary 1/11/2016

Arthur Cashin – Volatility is Back!

Echoes of 1937

Former Fed Governor Richard Fisher’s thoughts on stock market direction in 2016.

Dalio – One or two rate hikes in 2016? and then QE4??

I will gladly pay you Tuesday for a hamburger today.

– J . Wellington Wimpy

Volatility

We have been talking about the return of volatility since June of last year. In our June 2015 blog post titled Tick Tock we noted that the first half of 2015 had been one of the dullest in history. Sensing the end of the Federal Reserve’s zero interest policy we knew that volatility was sure to make a big comeback. In fact, Federal Reserve officials had been warning of just such an occurrence.

We should expect volatility from time to time. We are in a period of some uncertainty. -Esther George Kansas City Fed President Jackson Hole Economic Symposium

It was as if volatility had been banished to the waste bin of history by Central Banks. Well, we know things are never different and that volatility had to return with the advent of a change in central bank policy. That new central bank policy came courtesy of the United States central bank – the Federal Reserve. The Federal Reserve made the decision on December 16 of last year to begin the process of trying to normalize interest rates and hiked rates for the first time in over seven years.

Our good friend Arthur Cashin, a 50 year veteran of the New York Stock Exchange (NYSE) is a wealth of market knowledge and has an amazing array of friends to call on for their market research and insight. Arthur has probably forgotten more than most will ever know about market history. Last month Arthur pointed to Sam Stovall’s research on volatility during rate hikes. Sam Stovall is the Chair of S&P Capital IQ’s investment committee and has a tremendous track record of insightful research. I read everything that passes across my desk with Sam’s name on it.

In the past 50 years, it has been fairly common to see volatility rise, especially after the start of rate-tightening cycles. Indeed single-day closing price volatility saw an average 77% jump during the three months after the first in a series of rate hikes since 1967. In the three months prior to the December 16 rate increase, the S&P 500 experienced 21 days of closing price volatility in excess of 1%. History therefore implies that things could get even choppier in the months to come.

Yet this increase in daily volatility has occurred within a very narrow 52-week high-low price range. At 14%, this differential is 8th lowest since WWII. History shows that those years with narrow high-low ranges recorded the worst next-year price performances and frequencies of advance. In other words, 2016 will likely endure increased volatility, but without much in the way of price appreciation to show for it.

1937

Over the course of the last seven years it has been our contention (and the contention of those far smarter than I) that Federal Reserve monetary policy was responsible for the rapid rise in asset prices here in the United States. Federal Reserve policy is directly correlated to that rise and is in fact a stated goal of the central bank. Federal Reserve governors felt that a rise in asset prices would engender confidence in the economy thereby inspiring spending on new projects and help reflate the economic engine of growth. Former Dallas Fed President Richard Fisher was on CNBC last week and explained just how and why the Fed enacted that policy

The purpose of zero interest rates engineered by the FOMC, together with the massive asset purchases of Treasurys and agency securities known as quantitative easing, was to create a wealth effect for the real economy by jump-starting the bond and equity markets.

QE3 and its predecessor rounds front-loaded the equity market. Stated differently, I believe we engineered a version of the “Wimpy philosophy”: We gave stock-market investors two hamburgers today in exchange for one or none tomorrow. We pulled forward the price-reaction function of markets.

If that is a correct assessment, then there may well be a payback period of lesser movement in stock prices to follow.

 Former Dallas Fed Pres Richard Fisher 1/5/2016 CNBC

Whether that policy worked is a point of contention but having realized the gain in asset prices with the expansion of the Federal Reserve balance sheet what is to happen when the Federal Reserve changes course? We would expect that asset prices would also begin to change course. This is what we had to say in our Quarterly Letter back in April 2015 about the last time Federal Reserve officials were faced with this dilemma.

It has been our contention since the dawn of the crisis that central bankers would be faced with the same dreaded decision that was faced in 1937. 1937 was, of course, 8 years after the Stock Market Crash of 1929 and seen as THE seminal moment when officials made the Depression – Great.

 In 1937 officials began to pursue tighter monetary policies as the stock market had seen significant gains from its lows in 1931 and they feared another bubble forming. Our contention is not that policy was too tight in 1937 but rather that it was tightened at all. Monetary policy has its limits and we are seeing those limits now much as officials saw them in 1937.

The similarities are staggering.

 As a reminder, so you don’t have to go look it up, 1937 was one of the worst years ever for the stock market. The Dow Jones was down over 32% in 1937.

After seven years central bankers have gotten absolutely no help from politicians and now the Federal Reserve is worried that if the next crisis appeared with interest rates at zero they would have no policy response.

“The Fed is a giant weapon that has no ammunition left.”

Former Dallas Fed Pres Fisher 1/5/2016 CNBC

 What Next?

The Federal Reserve is on record as stating that they plan on raising interest rates four times in 2016. The market is currently pricing in two interest rate hikes. Who is correct? Seasonally, this is one of the stronger periods for the market and yet we have seen a 6% selloff in the S&P 500 in just the first six trading days of the year. That is the worst start to a market year in history. The Federal Reserve may have to change course rapidly if there is a break down in asset prices or a credit contagion that begins to form around the world.

Could Fed policy cause a recession in 2016? The Fed cannot abort the business cycle. If it does not come in 2106 it should not be long after. Recessions are a natural course of the business and market cycles. We accept them and invest accordingly. In recessions the US market has averaged a 38% decline over the last 100 years. We are late in the cycle.

However, while asset prices are high any move lower in asset prices will most likely be met with support from governments. Deflation is a government’s worst nightmare and they will do anything to prevent this. Russia, Japan and Brazil are already in recession and Canada and Korea are very close. The next weapon and possibly the last weapon in the Fed’s arsenal is direct debt monetization. Directly financed government spending known as “Helicopter money”.

We believe as much as Ray Dalio does, the billionaire founder of Bridgewater Associates, when he said in August that he believes that the Fed will reach back into its back on monetary tricks given a disruption in markets much as happened in 1936.

“We don’t consider a 25-50 basis point tightening to be a big tightening,” Dalio wrote in a LinkedIn post. “While we might see a tiny tightening akin to what was experienced in 1936, we doubt that we will see anything much larger before we see a major easing via QE.”

Defaults in the high yield market are starting to spread as may counterparty risk. This will be exacerbated if Saudi Arabia continues its oil supply policies. Capital has been poorly allocated in the oil patch due to Federal Reserve o% interest rate policies. Now Saudi Arabia is putting the squeeze on shale oil producers here in the US but maintaining higher than necessary supply levels. How long can the Saudi’s afford to pressure US shale producers? We don’t know but when their polices change it will be with less producers around producing less oil which in turn will produce higher oil prices.

A struggle may be coming as the US changes course on interest rates and emerging economies and governments struggle with paying US denominated debt. That may spill over to developed markets and banks. We believe that we here in the US have less to fear as authorities and banks have spent the last 7 years rebuilding the balance sheets of US banks. Europeans however, have not. They may have more to fear of an emerging market debt crisis.

We need to adjust our investing to the current winds. We foresee 2016 as being a tactically driven year. We feel that changing our positions tactically with the ebb and flow of the market, decreasing the volatility of our portfolios by increasing positions in bonds and bond like instruments while also paying attention to companies that have pricing power like technology and health care will be the key to performance. Cash also becomes an important part of asset allocation because it is the only way you can mitigate the correlation breakdowns we are going to go through, at least until the Fed enacts the next Quantitative Easing when cash will become a burden.

Never Just One Cockroach

History suggests two immediate consequences from tightening: higher volatility and lower valuations, meaning earnings and ultimately the economy are left to drive prices. Psychologically, bulls and bears will get an answer to a question that has lingered over markets: how much of the Standard & Poor’s 500 Index’s 202 percent jump since March 2009 is sustainable without stimulus? – 12/16/15

http://www.bloomberg.com/news/articles/2015-12-16/pulling-life-support-from-a-bull-market-on-the-brink-of-history

As you probably know the Federal Reserve raised interest rates this week for the first time in over 7 years. The changes to that policy are bound to have some sort of negative repercussions exacerbated by an environment where all other of the large central banks are still in easing mode. We have spoken before about the effect of the US Dollar on Emerging Markets and commodities and those effects will only be worsened by the changes in Fed policy. We are not saying that Fed policy is wrong we are just looking out for the Piper to be paid.

 The buildup in government debt, he said, “tries to prop up the economy at the expense of the future.” Zero-interest-rate policy pushes consumption forward and changes the discounting mechanism, he said. Indeed, there no discount mechanism, he said, so you “fully value everything.”

“Once you’ve done all of those things you are quite a few yards into the tractor pull,” he said. “And that sled is getting heavier and heavier and heavier. That is why it is getting harder and harder to make money.”- Jeffrey Gundlach Doubleline Funds 12/8/15

 There is never just one cockroach. The biggest headline for us over the last two weeks is not the Federal Reserve policy change, as that was widely anticipated, but the redemption requests and subsequent suspension of those requests from the Third Avenue High Yield Fund. Third Avenue is a highly respected player in the institutional money game. This is not some fly by night Ponzi scheme. The fact is that Third Avenue got caught swimming naked when the tide went out in the high yield market. As you well know, the high yield market is dominated by energy companies and the descent of oil from its lofty perch has decimated that space. Understand that a redemption request is just investors looking to get money out of a fund and cut their losses. That is usually not a problem. However, when a fund suspends those requests they are saying that they need more time to come up with the cash. Selling too much, too quickly may upset the market for those assets and cause the fund to sell at fire sales prices. As for the broader market this can cause a cascading effect. If this fund sells at a huge discount then other may be forced to sell and we create a viscous spiral. So they put up the gates. By putting up the gates investors search elsewhere for liquidity asking others funds for cash and forcing them to sell. And around and around we go. This is what crises are made of.

The large spread between the top 10 stocks in the S&P 500 and the rest of the market is also flashing a warning signal. A bifurcation in the markets is a sign that the rally has gotten too constrained and is losing steam.

The S&P 500 has a big performance issue that should be a focus for investors: Too much of the index return is coming from too few of its stocks.

The 10 most valuable companies in the market are up roughly 14 percent as a group this year, versus a loss of close to 6 percent for the rest of the stock market.

That 20 percentage-point spread between the biggest stocks and the rest of the index is the widest since 1999, heading into the dot-com bust.

A widening of the spread between the market’s best performers and the rest of the market should be viewed as a cautionary sign. Jason Trennert Strategas Research Partners 12/9/2015

http://www.cnbc.com/2015/12/09/its-back-a-bad-sp-500-data-point-last-seen-at-dot-com-bust.html

We continue to see an upswing in volatility here in the 4th Quarter of 2015. We believe that will continue in 2016.  While we are cognizant of low returns in this environment we have believed it prudent to have cash on the sidelines. We are now getting closer to putting some of that to work given lower asset prices in response to Federal Reserve policies. We expect 2016 to be a year full of volatility and opportunity. We wish you all a very Merry Christmas and a Joyous Holiday!

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.

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.

Investors Spooky October

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

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

While the S&P 500 has moved back into the trading range that it occupied in the first half of 2015 it that would indicate that, at the very least, the market is due for a breather. We believe that the current upside in the market is therefore limited and that a pullback is not only likely but healthy for continued market gains. We are concerned about the lag in Small Cap stocks and what that may indicate for the market in the near term. We saw an exciting rise in Large Cap indexes in October but their Small Cap brethren have not kept pace. Usually, that signals a weakness in the market as investors flock to the relative safety that Large Cap stocks provide rather than seek out the higher risk/reward paradigm of small cap growth. This anomaly could also indicate a near term change in direction of stocks.

The current general consensus is for the market to make further gains as the traditional Santa Claus rally appears into the end of the year. We believe that the October rally has brought forward much of those gains and further gains into the end of the year will be muted. We would expect the market to take a breather and settle into a trading range as we close out 2015. It is a little early to foresee what 2016 holds in store but given the volatility that we have since August of this year we believe that 2016 will continue in the same vein and be a volatile year. While higher volatility does not indicate a top for the market higher volatility does tend to appear in the last act of an aging bull market. We could be seeing a market that compares in time to the 1999-2000 market when the Federal Reserve was preparing to raise interest rates.  We believe that 2016’s returns will be +/- 20% for the year. Not very exact or comforting but it does allow us to plan. That plan would include more and larger tactical moves than we have made in the recent past.

“What you saw in the third quarter of this year could well have been a harbinger of things to come over the next year or two,” Bruce Karsh, CIO and cochairman of Oaktree Capital Group said October 29 after the company reported earnings. 

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

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

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

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

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

Wild Week in the Market and How Investing is Like Buying Groceries

This week along with some sharp turns in the market came some interesting comments on Federal Reserve policy and markets came from Ray Dalio, the investment guru and world’s largest hedge fund manager. Dalio, the founder of Bridgewater Associates feels that the Federal Reserve, while they may raise interest rates soon, will be forced to enact another round of Quantitative Easing (QE). QE is the purchase of assets by the Federal Reserve to stimulate the economy. It increases the size of the Fed’s balance sheet and provides support to equity prices. Much like in 1936 the Fed finds themselves painted into a corner and addicted to quantitative easing. In 1936 the Fed raised rates for the first time since the 1929 stock market crash and that tighter monetary policy caused a recession which sent equity prices tumbling. Will the Fed do that again? They are certainly trying to avoid that but must get interest rates above zero. Dalio expects a major easing from the Fed. Could we see rising interest rates courtesy of the Federal Reserve AND QE? We are contingency planners and must provide for all outcomes.

 

http://www.marketwatch.com/story/bridgewaters-ray-dalio-clarifies-prediction-that-fed-will-roll-out-new-qe-2015-08-26

 

On Monday of last week the S&P 500 was over 4 standard deviations away from its 50 Day Moving Average (DMA). That is level that would denote an extreme move in a short amount of time. The last time that this occurred was in August of 2011 when the United States sovereign debt was downgraded. The following week the S&P 500 rallied over 7%. We felt that Monday was an appropriate time to put cash to work for our more aggressive clients. By the end of the week we had seen a 6.3% rally in the S&P 500 from its lows and we felt that taking some profits in a tax efficient manner was appropriate. History has shown that sharp selloffs like this tend to have reflex rallies that are prone to failure. Having seen sharp declines investors are likely to scale back risk exposure and that produces overhead resistance to stock prices. We would not be shocked and are quite prepared for the downside in prices to resume next week. Now is a very good time to reassess one’s appetite for risk and whether that is commiserate with one’s risk exposure. If you didn’t sleep well last week you need to have less risk in your portfolio. If the market selloff didn’t interfere with your zzzz’s or you felt like buying on the dip then your risk is either okay or could be increased. Take some time and think about how you reacted last week.

It is going to be another fun filled week. These are the times that we thrive on and live for. Dislocations in markets provide opportunity. You can see things as problems or opportunities. If you are prepared then it is an opportunity. We are prepared with an underweight in equities and quite happy with market moves lower and dislocations. We are shopping for groceries and want to see lower prices. As Warren Buffett has often said, “Why would anyone want higher stock prices”? Know that we have room in our basket and are looking for groceries in the discount aisle.  

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 August 30, 2015 at 10:15 am  Leave a Comment  
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Fickle Stock Markets and Daughter’s Driving

‘There are decades where nothing happens; and there are weeks where decades happen.’  – Vladimir Ilyich Lenin

It has been some time since our last quarterly letter but then again not much of anything of consequence has happened since the summer began. As you can see from our above quote, stolen from Vladimir Lenin, this week has seen some market moving news. China’s devaluation this week felt earth moving. A little background perhaps? Currencies are a tool which governments can use to speed up or slow down their economies. China has seen a serious deterioration in its export driven economy in recent weeks. A weaker currency is a lever to pull to get exports going again. Look at the relationship between the US and China. If I wanted to buy Chinese manufactured goods I would use US Dollars to do it. If the Chinese currency goes lower versus the US Dollar than my Dollars go farther. Instead of it costing $600 dollars for a piece of furniture maybe it only costs $540 now. If I am a dealer here in the US maybe I increase my purchases by 10%. A nice little jumpstart to the Chinese economy and cheaper goods here in the US. Cheaper goods is a good thing right? Well, maybe not so much. You now have the idea that China is not only exporting goods but cheaper goods and prices begin to fall. The Federal Reserve here in the US has been trying to ignite INFLATION and not having much success. Now we may be seeing waves of deflation hitting our shores further pushing the Federal Reserve into a bind. China is now exporting deflation around the world.

This puts the Federal Reserve in a bigger bind than they were previously. The IMF and World Bank have asked them not to raise interest rates. Higher interest rates in the US will only make the Dollar rise faster and higher. Why is that a problem? I can go travel internationally for less money. The problem is that many countries tie their currencies to the US Dollar. Their currencies are rising and that is harming their economies. These countries may have to devalue their currencies and around and around we go in a race to the bottom. Eventually something will have to give. For now my money is on a currency like the Malaysian Ringgit. A currency in a far off land none of us are concerned about until we are all very concerned. This sounds much like the beginnings of the 1997 Asia Financial Crisis. That crisis started with the collapse of the Thai Baht. The crisis migrated its way to Russia where they defaulted on their debt and soon to the US where the collapse of a large hedge fund forced the Federal Reserve to intervene. We are all interconnected. Watch out for currency crises.

From Jason Goepfert of SentimenTrader comes an interesting statistic. Friday’s have historically been up days in the market. No one likes to have risk on a weekend so shorts like to cover. Shorts have infinite risk. If you are short over a weekend and the company that you are short is purchased you have infinite risk. Not much fun at the beach worrying about that so you cover your position driving prices higher. Goepfert points out that over the last 3 months out of 12 Fridays the S&P 500 has been down 10 times. Investors seem to be seeing the glass as half empty and not half full with the unexpected weekend surprise being skewed to the downside.

Clients are asking about my feelings on commodities and crude oil in particular. Anecdotally, I am hearing advisors ask about eliminating commodities from model portfolios. As clear as a bell being rung we may be closer to the bottom in commodities than the top.

“Corporate insiders in the energy sector have dried up their selling activity while making some buys. At the same time, sentiment on crude oil has soured to one of its worst levels in over a decade. When we’ve seen this kind of difference in opinion between insiders and public, energy stocks have consistently rallied.”  –  Jason Goepfert – Cashin’s Comments – 7/28/2015

When there is no one left to sell…

Keep an eye on gold, silver and oil but especially copper. Copper may tell us whether China – the global growth engine- is getting back on its feet.

It is getting harder and harder to generate a return in these markets. The S&P 500 has moved in a 5% range since last November when the Federal Reserve stopped increasing its balance sheet. Bonds have continued to do well as interest rates are back to recent lows. The 200 day Moving Average (DMA) is critical support on the S&P 500. China’s actions may be the key. If they continue to let their currency depreciate then markets may suffer. Keep an eye on the US Dollar. If the Federal Reserve raises rates while China continues to depreciate then the probability of downside risks accelerate. We could be in for a bumpy ride here. September and October can be the cruelest times of the year for investors.

The Dow Jones Industrial Average has swung to either side of breakeven in 2015 over 20 times. No other year has been so fickle, the closest being the 20 times the blue chip index swung in both 1934 and 1994, according to research compiled by Bespoke Investment Group. This shows the lack of conviction by market participants going back to last November. As a reminder, 1934 finished up 4.1% for the year while in 1994 the Dow Jones closed higher by just 2.1%. The years after the most fickle years look like this. 1935 was up 38.6% and 1995 was up 33.5%. Not enough data to go on but we will keep digging.

My oldest got her Driver’s License on Friday. Time is flying by. After her test, the first thing that I did was call my insurance agent. For all of you, this is a good time of the year to check out your insurance and make sure that you are getting the most bang for your buck whether it be home, auto, life or liability. If you need help I have some excellent resources for you. As a disclosure I am a fee only Registered Investment Advisor. I do not make money on your insurance needs. My only goal is to help you protect your assets and save 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.

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.

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