The Trump Rally Meets The Swamp

The Trump Rally while rooted in ideology and investment theory is not necessarily rooted in reality. While tax reforms, reduced regulation and fiscal stimulus could make for a powerful combination stoking the economy and inflation it is not certain this combination will actually happen and if it does happen it will not happen for some time. Expectations are running a bit too high and this is still Washington DC after all. The roots of the Trump Rally are bound to get stuck in the mud of the Swamp.

Interest rates and the US dollar are rising which can be a dangerous combination. The market can rally with rising interest rates and we believe that it is healthy for interest rates to rise from here and that low interest rates were actually inhibiting growth in the economy. Some semblance of higher interest rates are good for the economy. But for the stock market the current high level of valuations were predicated on TINA (There Is No Alternative). At some point, bonds, real estate or other asset classes become an alternative. The high levels of asset valuations were predicated on low interest rates as all investments are evaluated versus the risk free rate of the 10 year Treasury. A rising ten year means that models may have priced assets too richly.

As you know we follow certain financial leaders and Jeff Gundlach at DoubleLine is one we find most open with his thoughts. Gundlach is on record saying that the 10 year could go to 6% in the next 4 or 5 years. We are of the same thought although not as drastic. In the near term we believe that yields have gone too far too fast along with equities in the post Trump win world. Gundlach spoke to Reuters this week and caused markets to pause as he said much the same. Gundlach feels that the bond selloff has seen its low for now and stocks will take a breather before Inauguration Day. After he spoke bonds rallied and stocks fell. Evidently we are not the only ones listening intently to Gundlach’s views.

Another one of our favorite investing legends is Stanley Druckenmiller. He spoke this week at the Robin Hood Conference in NYC. Druckenmiller does Gundlach one better. He believes that the yield on the 10 year will rise to over 6% in the next year or two!! Druckenmiller is shorting the Euro and the Yen and he believes that if the 10 year rises above 3% then the stock market could see a 10% correction. Let’s face it. The stock market can face a 10% correction if someone sneezes in the Middle East.  A 10% correction is not something to be feared but anticipated. I think that the real takeaway is that at some point the yield on the 10 year becomes more enticing to investors than being in the stock market. The pendulum will swing and bonds will usually give you the correct signals. Keep an eye on the 10 year for hints as what stocks will do.

This Sunday’s referendum in Italy is the markets next boogeyman. Journalist and pundits are predicting the next great financial calamity if there is a “No” vote in Italy. Where have we heard this before? Italy has had 67 governments formed in the last 70 years. Why should 2017 be any different? We don’t mean to diminish the battle that is going on with bad loans at some of Italy’s biggest banks but somehow after seeing the predictions that Brexit would be bad for markets and Trump would be bad for markets we have a hard time believing the next great financial calamity follows the next populist regime change. The Italian Referendum should be another interesting vote. It might be time to become familiar with the name – Beppe Grillo.

Market is working off its collective over bought and oversold conditions. The 10 year closed Friday at 2.39% and should see resistance at the 2.5% level. Stocks have relieved some of their overbought condition but the Trump Rally is seeing some buyer’s remorse at 2200 on the S&P 500. Keep an eye on Italy this weekend.

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

The Market’s Violent Transition

“There are decades where nothing happens; and there are weeks where decades happen.” 
― 
Vladimir Ilyich Lenin

This was another busy week for the markets in the aftermath of the Trump victory. There has been a sea change in the outlook for markets going forward which is much more predicated on the House, Senate and White House being controlled by Republicans than it is solely about Trump. A stranglehold on DC by the Republicans will enable them to pass legislation to help stimulate the economy and perhaps stoke the fan of inflation. We had some bright minds check in with their thoughts this week. Ray Dalio proffered his thoughts on LinkedIn this week on the Trump win and where that takes the investing landscape. Dalio feels that we are at a major reversal point that may last a decade.

As a result, whereas the previous period was characterized by 1) increasing globalization, free trade, and global connectedness, 2) relatively innocuous fiscal policies, and 3) sluggish domestic growth, low inflation, and falling bond yields, the new period is more likely to be characterized by 1) decreasing globalization, free trade, and global connectedness, 2) aggressively stimulative fiscal policies, and 3) increased US growth, higher inflation, and rising bond yields. 

As for the effects of this particular ideological/environmental shift, we think that there’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation. 

 The question will be when will this move short-circuit itself—i.e., when will the rise in nominal (and, more importantly, real) bond yields and risk premiums start hurting other asset prices. 

https://www.linkedin.com/pulse/reflections-trump-presidency-one-week-after-election-ray-dalio?trk=hp-feed-article-title-publish

The key to success here will asset allocation. The early winning sectors out of the gate are financials, materials and industrials. The losers are bonds, utilities and REIT’s. We will be looking towards oil as we have been writing about for several weeks. The bottom may be in for oil as $60 a barrel looks far likelier than a revisit to the lows of $20 a barrel. US Treasuries have been absolutely hammered since the election and we suspect while the 30 bond bull market in bonds is dead but a trade-able low in bonds may be at hand as bonds are oversold.

We have been prepared for this upward move in bond yields as we sought cover by lowering our duration for our investors. We believe the 30 Year could move to 5% over the next five years. We were shocked to hear Jeffrey Gundlach, whose prescient calls we follow in the bond market, is predicting a move in the 10 Year to over 6% in the next five years. A move of that magnitude is what Dalio is speaking of when he relates that at some point bond yields will move too high for stocks. At some level investors will prefer bond yields to stocks and stocks will falter. At what level that occurs is the current $1 Trillion dollar question.

 Future inflation expectations are soaring. We believe in the sea change that Dalio and Gundlach are espousing with regards to inflation and higher bond yields. In the short term it appears as if everything is currently either overbought or oversold as we have entered this violent rotation out of bonds and bond like instruments into equities. The markets going forward may soon turn their attention to an exit from the EU by Italy as their referendum is fast approaching. For now, 2190-2200 on the S&P 500 is resistance while support is anywhere lower as the buy the dip crowd is back, although, investors will be buying financials rather than utilities. Things may have moved too far too fast. We think that bond yields will soon revert lower if only to relieve their oversold condition but it appears the 30 year trend has changed.

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.

Shock Waves

 “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

What the heck was that? An unexpected Trump victory sent shock waves through markets this week. What was once up is now down and what was down is now up. You have probably heard various explanations to this weeks 5% rally in the stock market. Here is my take. While many predicted that markets would sell off 5-10% in light of a Trump victory traders took their hints from the Brexit vote back in June. After the Brexit vote markets sold off but then rallied furiously. So this time, traders never let them sell off. Thinking like an old floor trader we saw many investors get caught offside. When everyone is on the same side of the boat the exits get small.

As we have written before Wall Street is agnostic when it comes to the election. They just want to know which way to bet. They got it horribly wrong and that wrong-footedness contributed to the volatility that we saw this week. Longs needed to be sold and shorts bought. The deflation trade was sold and the inflation trade was bought. Bonds, REIT’s and utilities got pummeled while financial stocks and biotechnology ran higher reversing their courses from the past year.

Going forward the street is betting on US dollar trades and less on globalization of trade. They also see inflation coming back with the Republicans running fiscal deficits and increasing spending on infrastructure while controlling both Houses of Congress and 1600 Pennsylvania Avenue.

Market internals tell us that something is amiss. While markets ran up 450 points after FBI Director Comey cleared Hilary Clinton and what seemed to be her path to the White House markets rallied 500 points when Trump sailed to victory. Also, declining stocks have been higher than advancing stocks while the market hits new highs. According to Arthur Cashin at the NYSE the market saw the largest number of simultaneous new highs and new lows in nearly 50 years. Not a sign of strength.

We believe that the path going forward is to continue to follow the aftermath of Brexit on British markets. While a honeymoon period is to be expected we believe that, as has been the case in Britain, as the honeymoon ends equity markets will begin to consolidate their gains post election and gravitate towards their lows of election night. Market closed on Friday at 2164 on the S&P 500. For now, resistance is at 2170 and then 2190. Market is now overbought and should take a breather here. Lots to come in the next month with the forming of a Trump Cabinet, an Italian referendum that could spell further problems for the EU and a likely rate increase here in the United States.

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 November 12, 2016 at 11:00 am  Leave a Comment  
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Controlled Burn

I believe risk is most when we feel it least and the risk is least when we feel it most. -Steve Blumenthal CMG

I read Steve Blumenthal’s weekly blog On My Radar every week. I don’t always agree with Steve but he always makes me think. His take on risk really struck a chord with me. I read it over several times. When the wine if flowing and markets are rising we don’t notice that risk is rising. Market moves lower create sheer panic. That gets our attention. It is then that risk is lower. Tops may or may not be forming but the signs are there. Investor complacency. Mega deals. High valuations. Be on guard.

http://www.cmgwealth.com/ri/radar-youve-got-remember-two-things/

Oil has taken a beating over the last week. The negotiations between the OPEC nations have seen more posturing and negotiating and that has oil backing away from $50 a barrel. We think that they are closer to the end of the negotiations than the beginning. Things for the Saudi’s at home are running a little tight and they need higher oil prices. The Saudi’s are looking for cooperation and we think they will make a deal. Right now oil is in a bit of a panic selloff and may seek to retest the lows. Goldman Sachs has piled on by calling for lower oil prices. Doing the opposite of what Goldman says publicly has been a great strategy for years.

http://www.zerohedge.com/news/2016-11-01/goldman-warns-oil-headed-low-40-declining-probability-opec-deal

Arthur Cashin pointed out on Friday morning that the market is on an extended losing streak and it has been picking up steam since breaking through the 2130 level we warned about.

The negative close made it eight down sessions in a row something the S&P hasn’t done since October of 2008 in the days following the Lehman collapse. The severity of the selling was far sharper in 2008. That eight session sell off dinged the S&P for 23% while this move has only sliced 3% from the S&P. 11/4/2016

Friday’s close made it 9 down sessions in a row. That makes for the longest losing streak in 36 years. The market is down only 4.9% from its all time high so this is acting as a very controlled burn. A Trump win could make for more downside but another 5% would be a very healthy 10% correction which we haven’t seen in a while. The big question is will the Federal Reserve still raise rates if Trump wins? That could help propel the selloff. We have our doubts that the Fed will have the stomach for it. If they do we could see cheaper prices. We have had heavy cash positions for some time. One year returns have gone negative on the S&P. Valuations have been high and that justified our cash position. History tells us that markets have struggled to rise from these valuation levels. The market has been stuck in a rut. We would love to see cheaper prices.

Market closed at 2085 which is just above our support level of 2080. Even a blind squirrel finds a nut from time to time. A break of 2080 brings 2040 into play but markets are very oversold and looking for a bounce. 2080 is support for now. We would not be surprised if we do not have a winner on Tuesday night. Gore v Bush. Hold all tickets!

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 November 5, 2016 at 8:20 am  Leave a Comment  
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You’ve Got Mail

Just when I thought I was out. They pull me back in.

 – Michael Corleone Godfather III

Was it Michael Corleone or James Comey Director of the FBI? Comey has to be thinking the same as the Godfather as Anthony Weiner’s emails have pulled Comey back into the Clinton investigation and thrown the election and markets for a loop. The S&P 500 was holding support above the 2130 level that we spoke of last week until the explosive news of a reopening of the Clinton email investigation hit the tape on Friday. Markets closed under 2130 for the second time triggering Jeffrey Gundlach’s warning. Monday is going to be a very important day for the short term direction of the market.

Mega mergers are not typically seen as very good for markets. In fact they usually serve as a warning post and signs of a potential top. We were served up with the news of three merger/takeovers last Monday morning. The largest being the ATT Time Warner deal. The AOL Time Warner deal served as the warning bell at the top of the 2000 bull market and the subsequent tech crash. When large companies have squeezed the last drop of growth out of their companies and the business cycle is near the top the playbook calls for buying growth. At the end of the business cycle the only thing left to do is acquire the growth that is not obtainable organically. ATT has recently seen a slowdown in the growth of subscribers. Is this the Hail Mary Pass for ATT? The AOL Time Warner merger is now studied in business classes as the classic failed mega merger. How will history see the ATT Time Warner merger? Better we suspect but sometimes they do ring bells at the top.

As far as the technicals go the 50 Day Moving Average (DMA) on the S&P 500 is now declining. Also, the last two weeks have seen market swoons instead of rallies at the end of the market day. Both serve as warning signs for a tired market. We are entering, which is historically, the best part of the year for stocks. The election and the Federal Reserve may have something to say about that. We are now staring at an election in chaos and a Federal Reserve committee meeting in December where they have all but promised the market that they will raise rates. Will they still raise rates if Trump wins and markets swoon? 2130 is being tested. Pass or fail?

The S&P 500 has now closed below its 100 day moving average for the third straight week. If 2130 fails then the next real level of support is the always critical 200 day moving average at 2078 on the S&P 500.

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.

Heavyweights

Two heavyweight investors took to the airwaves this week to give their views on current markets and Federal Reserve actions. David Tepper who manages Appaloosa Management and is one of the more successful hedge fund managers noted that he is “pretty light in the market and we have a lot of cash”. He is “pretty cautious “on the market right now and he points towards the election for that caution. He feels that if the election provides a shock to the market it could put the Fed on hold. If the market is not shocked by the election we could get a relief rally. It appears that he, like everyone else, is looking for fiscal spending to ramp up.

If the market goes down because of the election, Tepper said the Federal will also be less likely to raise its benchmark federal funds rate. But if the market holds at current levels, Tepper said the central bank will likely raise rates because the economy is “at a point where they should raise rates.”

“But if you do get some sort of mixed government or something that’s near what’s going on right now … then you’ll get some relief after this election’s over. I think they have to anticipate business investment going up, especially if you have more or less of a status quo economically,” Tepper said. This would include the Republicans retaining their control over the House, he added.

http://www.cnbc.com/2016/10/17/billionaire-david-tepper-im-generally-pretty-cautious-on-the-market.html

Jeffrey Gundlach was the other heavyweight investor to weigh in this week. Gundlach manages over $100 billion at DoubleLine Capital and we find him to be the single most valuable investment opinion to follow. He has given some prescient guidance since the crisis of 2009 and we have invested with great confidence in Double Line. While Gundlach is mainly known for his bond acumen he also espouses his views on equities. He gave an interview this week noting a critical support level of 2130 on the S&P 500. We closed below that level on Monday of this week. According to Gundlach, we need a second close below it to confirm more downside to the market.

Wiki leaks continue to drip. Denial of service attacks on the East Coast put a slight chill into markets. Pressure continues to build. The S&P 500 has now closed below its 100 day moving average for the second straight week. The next real level of support is the always critical 200 day moving average at 2070 on the S&P 500. Keep an eye on 2130.

Is this long national nightmare over yet? Vote early and vote often.

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.

Yellen – More Punch Anyone?

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens”.– John Maynard Keynes

Central bankers have an obsession with inflation. Inflation is the central banker’s temperature gauge for the economy. Inflation above a certain level is too hot and deflation is way too cold. The natural question is at what level is inflation too hot? Currently, the US Federal Reserve thinks that above 2% is too hot, so 2% is their target.

On Friday, in a speech in Boston, Janet Yellen, Chairperson of the Federal Reserve, stated that it might be wise to consider the upside of a “high pressure economy”. While the FOMC has targeted a 2% inflation rate it appears that they are preparing us to accept a higher than normal inflation rate in order to “heal” the economy. One is very quickly reminded of the Weimar Republic. Prophetically, our good friend Arthur Cashin from the NYSE had this to say in his blog this week.

Originally, on this day in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to “jump start” a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental “more is better” theory they simply created more and more money.

In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid-month it was $100 billion. Then it all collapsed.

By October of 1923 German citizens were burning cash instead of wood for heat. It was easier to get and less expensive.

In a normal environment it has been said that it is the Federal Reserve’s job to take away the punchbowl just as the party has started. On Friday, it appeared that Yellen not only doesn’t want the party to end she wants to spike the punchbowl.

We do not believe that the November meeting of the FOMC is live and that they will not raise interest rates at that time. Not days before a Presidential election. Traders are betting that there is a 65% chance that they raise rates at the December meeting. If they raise rates in December it could make for another rocky start to the New Year.

One of the most astute investors that we know is a long time friend who pops in on us time to time. He is a very patient investor and quite prescient in his market calls. He called us out of the blue this week. He senses caution and is taking money off of the table. When he speaks we pay heed.

Technical analysis, while voodoo for some, is a way of quantifying the current state of market psychology. The market has been forming what is called a wedge. A wedge is a state of an increasingly tighter price range. This tells us that the market has been forming pressure much like a volcano or earthquake fault line. The market may have broken out of that range this week. The market has been below its 100 day moving average for the last two weeks. What was once support for the market is now resistance. The next real level of support is the always critical 200 day moving average at 2070 on the S&P 500. That is about 3% lower from the close of 2133 on Friday. The market is currently up 4.6% Year to Date (YTD). Investors, and professionals who looking to keep their bonus checks, could get very anxious if this year’s gains are put at risk in an October swoon. Keep an eye on 2070.

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.

The Greatest Game

 

“Golf is deceptively simple and endlessly complicated; it satisfies the soul and frustrates the intellect. It is at the same time rewarding and maddening – and it is without a doubt the greatest game mankind has ever invented.” – Arnold Palmer

 

My great passions, besides my family, are golf and investing. They are very similar in their nature. As Mr. Palmer so eloquently stated both games are maddening but perhaps that is why they are so rewarding and satisfying. We enjoy that both games seem simple but are frustratingly complex and it is in conquering their complexity that we find such satisfaction.

The 3rd Quarter of 2016 was maddening as the entire quarter was spent watching and waiting for some sort of resolution to market direction. While investors and hedge fund managers went off to the beach, the market, with the exception of the first two weeks in July, looked like it went off to the beach as well. The S&P 500 was up 3.5% in the first two weeks of July and that is where it closed for the quarter.  Much like a duck it was about what was going on under the surface that counted.

The pressure in the market continues to build as the market stays range bound between 18,000 and 18,500 on the Dow Jones Industrials. The pressure, if you listen to the media, is increasingly blamed on the election but it is the course of central banker policy that should hold your attention. The election is merely a sideshow. Central bankers, while publicly stating that negative interest rates are working, are finding that negative interest rates in Japan and Europe are having serious consequences. The pressure is mounting on central bankers to claw back higher interest rates without disturbing the animal spirits of the market place which would knock down asset prices while hindering confidence in the recovery.

Deutsche Bank and Interest Rates

Of late, central bankers in Europe have also come face to face with another dilemma and that is the market is attacking the stock price of Germany’s largest bank, Deutsche Bank (DB). The market has begun speculating that Germany’s largest bank and perhaps the world’s most systemically important bank could be in trouble. While we don’ think Deutsche Bank is on the brink of failure attention must be paid. When Wall Street senses weakness they feed upon it. The market has a way of cleaving the weak antelope from the herd. Financial firms’ biggest asset is confidence in the institution itself. A bank is only as good as its promise that it will deliver on its obligations. If there is no confidence in the institution then it is no longer viable and money will flow away from it. A bank run is not always logical.

Markets are going to push Deutsche Bank, possibly to their limit. Markets have a way of fleshing out the weak players. Traders will get into to a position where they will profit from a fall in Deutsche Bank’s stock. It has been this way since the dawn of Wall Street. You could call them parasites but as speculators they perform a function. They keep the system honest and flesh out the weak hands. That is what capitalism is. We have seen it over and over again. This can be seen in the failure of Lehman Brothers, Bear Stearns and probably most clearly in the failure of Long Term Capital Management.

(In 1998, Long Term Capital Management was THE hot hedge fund full of famous Wall Street traders and Nobel Prize winners. They made increasingly larger bets that put them in hot water.  Traders around the Street got wind of their problems and garnered insights into Long Term’s worsening positions and bet against them until Long Term had to capitulate and be bailed out by the big banks.)

One of the biggest issues surrounding Deutsche Bank and the European banking system is the unintended consequences of negative interest rate policy. The current negative interest rate environment is curtailing bank profitability. By trying to save the European economy European Central Bank (ECB) officials are putting the solvency of their banking/insurance sectors and pension funds at risk.

From a macro perspective we see that not only can central banks no longer lower interest rates they must raise them to enable banks to make profits and heal their balance sheets. Danielle DiMartino Booth is a former advisor to Federal Reserve of Dallas President Richard Fisher and is now President of Money Strong and serves as a consultant on worldwide central banking. Here is what Danielle had to say on the current interest rate environment.

In a reversal of economic fortunes, today’s economy is in desperate need of higher rather than lower interest rates, of a normalization of policy to put a floor under the bloodletting in pensions, insurance companies and among retirees worldwide. – Danielle Martino Booth Fed http://dimartinobooth.com/the-overlords-of-finance/

Central banks are currently trying to keep zombie companies and banks from failing. They are not allowing capitalism and its creative destruction component to function. The capitalist system is designed and needs to allow weaker hands to fail and the system to heal and become stronger. That has been what is missing since the dawn of this crisis – The allowance of failure. The politics of it are not palatable. The system is weakened because of it. At some point authorities must allow creative destruction or we will end up in an endless series of crises and become like Japan with low growth and stagnation for decades. The piper must be paid. Pain must be felt. Could we be at the beginning of that realization? Rates must be allowed to rise so banks can make money and repair their balance sheets. Central banks may be forced to raise rates.

Do we think that Deutsche Bank is going to fail? No. The legal settlements will not be as high as the headline grabbing amounts suggested so far. The bank does have sufficient liquidity at the moment but bank runs are bank runs and if one begins for Deutsche Bank there is never enough capital. Bank runs are panics and cannot be reasoned with.  We look at the macro risks and opportunities. We believe that there has to be a Plan B in effect and the German government will step in if Deutsche Bank begins to fail. A lack of confidence in Deutsche Bank and a lower stock price will deny them the ability to raise more capital. Either the governments will have to back off and allow them to operate under less stringent capital measures or Germany may have to step in and take a large stake in the world’s largest derivative dealer. The contagion risks are too high worldwide. What we see from a macro perspective is that the ECB will have to back off its pledge of negative interest rates as the unintended negative consequences are too high. Banks need positive rates and a steeper yield curve to make money. You cannot have your banks fail. They are the plumbing of the economic system. If Deutsche Bank fails then Credit Suisse is next and so on. The dominoes fall. Central bank leaders need to make it easier for banks to generate profits and negative rates are killing banks.

http://www.zerohedge.com/news/2016-09-29/run-begins-deutsche-bank-hedge-fund-clients-cut-collateral-exposure

 Saudi Issues – Oil

 

The other issue that has had our attention all summer is the lingering dissension among OPEC members and talks to tighten oil supply. Saudi Arabia is the 800 lb gorilla in the oil markets and without a definitive commitment on Saudi Arabia’s part no supply cut will have any effect.  A younger generation has taken control in Saudi Arabia and has been attempting a different tack in managing its foreign policy and economy. This has led them to attempt a change in their oil policy. The Saudi’s have been trying to drive prices lower in order to maintain market share and perhaps drive Russian and United States policy in their favor. The continued oversupply of oil markets has had the effect of dragging down oil prices but the outcome may have been too painful for the Saudi’s to handle. Things in the Kingdom have gotten much worse for the rulers as social issues mount. The Saudi Arabian government was forced to tap the international bond market for the first time in decades in order to fund a large budget deficit approaching 16% of GDP.  Currently their stock market is tumbling and the default risk of Saudi Arabia is rising in world markets.

Efforts to manage the fallout from cheap oil gathered steam over the past two weeks. Policy makers have suspended bonuses and trimmed allowances for government employees. Ministers’ salaries were cut by 20 percent. The central bank also said it’s injecting about 20 billion riyals ($5.3 billion) into the banking system to ease a cash crunch.

Austerity will help Saudis reduce a budget deficit that reached 16 percent of gross domestic product last year

 

The benchmark Tadawul All Share Index is down 18.5 percent this year, the third-worst performer among more than 90 global indexes tracked by Bloomberg. The MSCI Emerging Markets Index has climbed 15.4 percent.

http://www.bloomberg.com/news/articles/2016-10-05/saudi-arabia-s-post-oil-plan-off-to-a-rough-start-in-year-one

Current Saudi policy of over production is not working and the latest negotiations among OPEC nations may be the royal family admitting defeat and enabling a fundamental change in policy. The Saudi’s’ must constrict production in order to raise prices which will entail them taking the brunt of production cuts.  By agreeing to those terms perhaps they can elevate the price of oil. Higher oil prices will bring greater supply especially above $55 a barrel here in the United States but the capitulation of the Saudi’s could indicate a broader policy reform that over time will help support oil prices.

Bubble in Central Bank Policy

High interest rates are going to encourage savings, and I think we desperately need savings. Take a widow: they don’t know what to do with the money. There is no way they can do anything with it unless they go into stocks. I think forced equity investing creates the bubble.”

When asked who do you blame for this mess, the legendary hedge fund investor had one name: Janet Yellen, who Robertson says “is unwilling to see the American public taking pain at all and because of that I think she is creating a serious bubble where serious pain is going to come.”- Julian Robertson Bloomberg 9/28/2016

 

We could be on the cusp of real change in how investors are maneuvering especially in reaction to higher interest rates. Because of low interest rates investors, and in particular retirees, have been forced into buying ever higher priced income producers. Those income producers, such as real estate and utilities, have become overpriced in historical terms. We are looking to pull back from those areas of the market. In addition, low volatility strategies are seeing increased downside risk due to leverage, risk parity strategies and the current correlation of stocks and bonds.

The Saudi’s are indicating a change of heart on production numbers as things in the kingdom are getting rough. Whether or not they will be able to get production numbers down is another story. We think that the major gains for the 30 year bond market are behind us but we do not see interest rates heading much higher in the near future. The Fed is too afraid to rattle markets and they will raise rates even slower than most think.

 

While we can make the case for markets to fall the fact remains that we are in a binary environment and stocks could sharply rise as well. Although we think that risks continue to be tilted to the downside. In making the case for higher stock prices we note that professional investors are under invested and under performing. According to Goldman Sachs only 16% of Large Cap money managers are beating their benchmarks. There are some very high levels of cash at mutual funds and under performing managers will be looking to protect their jobs. Also, central bank policy may be forced into buying riskier assets to continue to forestall another crisis. That means they may be forced to buy equities as the Swiss and Japanese have already begun to do. If under invested under performing mutual funds begin to chase the market and inflation begins to move higher central banks will be reluctant to take away the punch bowl.

The election could roil markets but we think that a rate rise from the Federal Reserve in December is the more likely suspect to press markets. If that is the case we could be in for a replay of late 2015 and early 2016.

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

 

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Fed Up

The S&P 500 had its best week since mid July as central bank largess was increased yet again. On the menu this week was a buffet served up by not only the Bank of Japan (BOJ) but by the United States own, Federal Reserve. The BOJ refuses to give up on its intention to foster inflation north of 2% and in doing so announced that it will now attempt to control (manipulate?) the yield curve in Japan. Analysts that we follow are polar opposite on their views of where the new Japanese policy has us headed. We value both analysts’ opinions. We are facing a binary environment and either outcome is possible. Japanese central bank policy will only succeed in driving a vicious cycle. If price pressure does begin to mount this new central bank policy will only drive more inflation. If deflation begins to rise central bank policy will only bring more deflation. Here is more from George Saravelos from Deutsche Bank. One thing that we are fully confident in is that we are at the precipice of a decline in confidence in central bank policy.

In a note titled “It may be over for the BOJ”, DB’s George Saravelos writes that “by targeting nominal rates the BoJ is relinquishing control of real rates. This creates a policy asymmetry that becomes highly pro-cyclical. Consider a negative demand shock that raises demand for JGBs and depresses inflation expectations. The BoJ will end up reducing the amount of JGBs it buys and raising real rates.Consider the opposite: a huge fiscal stimulus from the government that puts upward pressure on yields: the BoJ would effectively monetize the debt raising inflation expectations even further. We worry that a self-fulfilling tightening is more likely than an easing in coming months.”

However, once the curve starts shifting substantially, either parallel-shifting or steepening the central bank would quickly lose control as its intervention would only exacerbate the underlying move 

We are in a very binary atmosphere. We could tip towards recession without the necessary tools to fight it in central banker’s hands or inflation could rise with central bankers without the political will to fight it. Central banks are losing credibility and that could spiral out of control very quickly. 

Donald Trump, while trying to bait Fed Chair Yellen into raising rates, proved that the Federal Reserve does make political decisions as a decision to do nothing is still a decision. Confused? Think about how Janet Yellen feels. Get the Tylenol ready for Monday night’s debate. While Yellen was damned if she did and damned if she didn’t she managed to come out looking political anyway. Maybe this is Trump’s true genius. He accused Yellen of running a political body in the Federal Reserve and she by not raising rates looked political. We never thought that the Fed would raise rates in front of the election but that is because we know they are a political body. Let’s be fair. They have to play politics. Congress is their boss. That, in the end, is the problem and why they will never meaningfully raise rates. They are boxed in. I think though you can now bet on rate rise in December if Trump pulls off a victory.

Professional investors are under invested and under performing. According to Goldman Sachs 16% of Large Cap money managers are beating their benchmarks. There are some very high levels of cash at mutual funds and under performing managers looking to protect their jobs. While we think that a tightening and a downward move in assets prices is more likely we could start to move out control to the up side as well. If under invested under performing mutual funds begin to chase the market and inflation begins to move higher central banks will be reluctant to take away the punch bowl. Ironically, a Trump win could be the cover they are looking for to take it away.

Vicious and virtuous spirals could be headed our way. While we think the line on this game is for a tightening and markets to head lower we think that move down might have to wait until after the election. In a repeat of last year we could see assets move higher until December while 2017 could have some early bumps.

Squeezing the Lemon – Dalio and Gundlach

Ray Dalio spoke at the Delivering Alpha Conference with CNBC. He made interesting note that interest rates cannot be made materially lower and may in fact “go the other way”. As bond yields go down it has the effect of making stocks more valuable. The bond bull market that has seen interest rates on the US 10 Year sink from 15% in the early 1980’s to 1.5% today may be over and that tailwind that it has given us to invest may becoming a headwind. Interestingly, Jeffrey Gundlach of Double Line Funds presented his latest webcast focused on the same idea. The lemon has been squeezed. It is time to look at bonds a bit differently. Those of you have followed us for the last several years know that we have been bullish on bonds longer than most and that has served us well. It may be time to change that thinking.

http://www.cnbc.com/2016/09/13/bridgewaters-dalio-theres-a-dangerous-situation-in-the-debt-market-now.html

Deutsche Bank got word that the Department of Justice (DOJ) was looking for $14 billion to settle a probe tied to activity in mortgage backed securities. That is with a B. Why are we concerned about Deutsche Bank? DB is one of the world’s largest derivative dealers. They are a key linchpin in the financial ecosystem. The settlement will be much lower than $14B but any number above $4billion could bring into question Deutsche Bank’s capital position. European banks are already under extreme pressure with negative interest rates severely impairing their ability to make money. DB and Italian banks are on our watch list.

Explosive devices in NYC lend help to Trump. Markets may not react positively to a Trump victory and may be leaning a bit too heavily towards factoring in a Clinton victory. Not making a statement here. The deal is Wall Street doesn’t like uncertainty. Trump has no political track record and the Street has no way of knowing where to place bets on a Trump victory except that he just might shake things up. Clinton is the status quo. The Street doesn’t like uncertainty.

Federal Reserve and Bank of Japan opine this week. Things may be quiet until then. We don’t expect much. The Fed is going to be wary of raising rates in front of an election that is running very close. It is also a great excuse to hold steady as they are terrified that the market might go down on a rate hike. The Fed may never raise rates again until there is a change in leadership at the Fed. Their current policy of waiting until the perfect time will never work. There is always something to be afraid of.

Stocks and bonds have been uncomfortably correlated. That means stocks and bonds have been going in the same direction. An asset allocation between them relies on them going in opposite directions. Risk Parity funds have been taking a hit of late. They could be forced to de-lever and raise cash. Market is sitting right on its 100 day moving average and that has Momentum traders on edge.  Market could swing sharply in either direction. Watch how stocks and bonds relate. Stay on your toes.