The Drive Higher

The big story this week was that the Federal Open Market Committee’s (FOMC) minutes were released from its last meeting. In those minutes it becomes clear that the FOMC is looking to reduce its balance sheet. Long time readers know that we feel that it was the increase in that balance sheet that helped greatly influence the stock market rally and raise prices of virtually all asset classes in the post crisis period. Any reduction in that balance sheet would logically have the opposite effect at some point. If the FOMC were to roll off its balance sheet the valuations of equity markets, driven higher due to easy money policies, may not be able to maintain their currently elevated plateau. Earnings alone will not be able to expand market multiples.

The bottom line is that the Fed needs more weapons to fight the next recession. The Fed must reduce its balance sheet before they raise rates further. If they begin to roll off the balance sheet it becomes another weapon for them to use because they can stop and start the process or move it faster or slower. If they remain static it is a liability and not an asset.

We have been pointing towards a looming crisis in the municipal finance area. The latest on our radar is the state of Connecticut. Connecticut’s largest moneymakers have been leaving town and sticking the state with the bill. Big earners know tax law and are incentivized to leave the state for greener pastures of low tax states like Florida. Atlas is shrugging. Courtesy of zero hedge comes the following.

The latest figures showed that tax revenue from the state’s top 100 highest-paying taxpayers declined 45% from 2015 to 2016. The drop adds up to a $200 million revenue loss for Connecticut. Connecticut Tax Cut

Oil had a rough week but it did manage to crawl back and close higher on Friday. It failed to close above the critical $50 a barrel on West Texas Crude (WTI). Equities are breaking out of the range that they has been trapped in for the last 3 months. The range of 2330-2400 on the S&P 500 was broken this week as the market closed on Friday at the 2415 level. This breakout could extend to 2475 if it gets legs. For now, volume is low and the few big leaders are influencing the advance. Summer markets are more prone to sharp moves as investors head to the beach. Our main thesis still holds that the market heads higher post Donald Trump’s victory with a move much akin to 1987.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

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.

 

Trump Troubles

A roller coaster runs up and down spins around and around while finishing where you started and it probably cost you money. – Arthur Cashin

We all rode the rollercoaster this week.  While there was plenty of noise and bluster the market fell less than one half of one percent this week. We feel that the volatility in the market was more about the massive positioning of trader’s being short volatility and not as much about Trump. Trump is just the excuse. Could this be a warning shot across the bow in the crowded volatility trade? Perhaps. Be careful. We are entering a slow period for the market seasonally. There just aren’t as many players around during the summer months and moves could become more pronounced. I, for one, would welcome back some volatility. It keeps investors onsides.

Financials are very important to the bullishness of the US stock market. The yield curve is flattening. That means that the bond market sees the economy slowing and the prospect of higher rates on the long end decreasing. The Fed will not be able to continue to raise rates if the economy is faltering. Financials are probably the most important sector of the stock market. Without financials it is hard to get the index to extend higher. The market is pricing in a June rate hike but chances are diminishing that the Fed will be able to raise rates a third time in 2017. Trump’s troubles make a fiscal bump less likely. If you have followed our blog you know that we made the case that a Trump bump from fiscal stimulus would give the Fed cover to raise rates. If that gets lost in the swamp then it makes the Fed’s job a lot more difficult. Our next point of interest is the Fed’s balance sheet. They are making noise that shrinking it is becoming a priority. That will be a huge factor in 2018.

West Texas crude was able to hold its recent lows and was able to close this week above the psychologically important $50 a barrel level. It could be just a bounce off of the OPEC meeting and Russian compliance or we could be seeing more growth worldwide. Oil has a top on it as if crude goes higher as more shale players will come online capping the price of oil but it is worth watching as an indicator of growth around the world.

Given all that happened this week the market is still stuck in consolidation mode. Emerging markets and Europe have been the place to be but Brazil took a hard shot this week. Keep an eye on Brazil. Impeachment is a strong word. Given the very small sample of US Presidents that have been on the impeachment trail stock markets have not reacted negatively in the longer term based on the impeachment process. Having said that, impeachment is also not likely given that Republicans control the House, that is until the midterm elections in 2018.  It is hard to argue against the bull thesis as the market continues to hold its recent range of 2330-2400 on the S&P 500. Until we break decidedly below 2330 we hold on to the bullish thesis.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

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 May 20, 2017 at 8:24 am  Leave a Comment  
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Gradual Squeeze

Local governments are in serious trouble as we are now seeing in Puerto Rico and Connecticut. High taxes, capital flight and pension obligations are going to meet the new order. We see technology and social changes on the horizon that continue to cut out the middle man and the ultimate middle man is government. Driverless cars? No more speeding tickets, DUI’s, parking tickets and lower drug arrests from stopped vehicles. All bring in less revenue for your local and state government. About seven years ago Meredith Whitney offered that muni defaults would begin to rise. She was laughed out of the building.

Ray Dalio is CEO of Bridgewater Associates, one of the largest hedge funds in the world. Ray takes into account not just the numbers as his theories about investing are more all encompassing about where we are in the cycles of debt and the economy while taking into account social and political factors. In his latest blog post on LinkedIn he had this to say on the current environment. We have taken Ray’s thoughts and applied them to muni bond investing. Time to think about a gradual squeeze in muni’s and rising default rates?  https://www.linkedin.com/pulse/big-picture-ray-dalio

At the same time, the longer-term picture is concerning because we have a lot of debt and a lot of non-debt obligations (pensions, healthcare entitlements, social security, etc.) coming due, which will increasingly create a “squeeze”; this squeeze will come gradually, not as a shock, and will hurt those who are now most in distress the hardest.

Central banks’ powers to rectify these problems are more limited than normal, which adds to the downside risks. Central banks’ powers to ease are less than normal because they have limited abilities to lower interest rates from where they are and because increased QE would be less effective than normal with risk premiums where they are. Similarly, effective fiscal policy help is more elusive because of political fragmentation.

Wells Fargo’s unauthorized account scandal is growing. It is now estimated that they created over 3.5 million accounts. If you are still with a traditional broker and not a fiduciary you should ask yourself, “Why?”

Commodities continue to have a rough go of it. Iron ore, copper, and rubber are all well off of their highs with iron ore down 20% and rubber down 30%. The tightening of money in China is having a chilling effect on commodity prices around the globe. West Texas Crude (WTI) rose about 3% on the week but is still under the crucial $50 a barrel mark. Keep an eye on oil for clues about the economy and stock market. The Saudi’s are looking to IPO their precious Saudi Aramco, the largest oil company in the world, and are going to want oil prices higher in order to get more money into their treasury. The Iranians and the Russians may try and pump more oil in order to push prices lower as their interests run counter to the Saudi’s. OPEC meets on May 25th. Oil has been on a roller coaster in 2017 and we do not think that the second half of the year will be any different.

The market is still stuck in consolidation mode. The S&P 500’s leadership continues to help pull the index higher while the amount of stocks above their 50 day moving average drops from 80% to 50%. Things are getting narrow at the top. This could be another sign that investors should be adding active management back into their portfolio. Stock trends continue as Hong Kong, England, Brazil, Japan, and the US all continue to consolidate gains or head higher. China? Not so much. Hard to argue against the bull thesis as the market continue to hold gains or plow higher. We think a southern neighbor could be the next leading stock market.

We still expect the market to break out of its recent range to the upside and in favor of the bulls. More often than not when a market consolidates a major move it breaks out of that pattern the same way that it came into it. It’s all about momentum and the animal spirits of the market.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

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 May 13, 2017 at 8:51 am  Leave a Comment  
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Crackdown, Smackdown and Fever

Two areas of asset pricing that we always keep an eye on in an attempt to decipher the market’s next move are US Treasuries and the oil patch. Let’s take a look at the current oil market and the commodity sector. Falling oil prices indicate lessening demand and therefore a lagging economy. In a nasty selloff oil is now down 11% in the last 3 weeks. There are rumors of major oil focused hedge funds liquidating or taking all risk off of their books as the price of oil swiftly moves lower. All of this while copper takes a tumble too. A falling oil price (and copper for that matter) does not bode well for the economy, high yield stocks or the stock market. When we talk weak commodities our thoughts immediately turn to China. The recent selloff in the commodity sector is being linked to a tightening of monetary conditions in China. A crackdown by the Chinese government is leading to higher interest rates and a tightening of the money supply in an effort to deleverage the economy. That, in turn, leads to lower commodity prices as China is one of the world’s largest consumers of commodities. A slowdown in China needs to be on our radar.

We have also been seeing a drift lower in hard data on the US economy. This data has been dragging since the failure of Trump & Co. to repeal Obama Care the first time in March. It seems that the market is waiting on some good to come out of Washington DC. We should never count on anything to come out of Washington DC.

The market is stuck in consolidation mode. In spite of recent data on a slowing economy we still expect the market to break out of its recent range to the upside and in favor of the bulls. More often than not when a market consolidates a major move it breaks out of that pattern the same way that it came into it. It’s all about momentum and the animal spirits of the market. That would mean we break out to the upside. There are lots of negatives about like weak US data, a Chinese slowdown and massive insider selling by US Corporate executives but the market refuses to break down. Many astute investors are warning about valuations in the market and are taking down risk.  They could be forced to chase the market higher adding fuel to the fire of animal spirits.

There is currently a massive speculative fervor in the crypto currencies like Bit Coin and Ethereum. A speculative fever has broken out and it is suspected that a lot of that money is coming out of China as capital controls are implemented and from Japan where a tax on investing in crypto currencies is going to be waived soon. Please approach with caution! This market is moving fast.

This may be a bit too inside baseball but the lack of volatility is important to watch. One of the most popular trades on the street over the last few years has been to sell volatility. Massive selling of volatility compresses the price of volatility, the numbers of players executing this strategy increases with the trade’s success and it brings in more and more investors to the trade. The word is that 95% of the float in VXX (Volatility ETN) is being used to short volatility. Ladies and gentlemen 30% would be large, but 95%!! The boat is listing to port as too many investors are in on this trade. This will explode violently in their faces. We don’t know when but it will. It always does. The risk parity trade and the selling of volatility combined with the reliance on passive investing ETF’s with High Frequency Trading market makers create a structural weakness in the market and will at some point create an opportunity for those with cash when the time comes. Forewarned is forearmed.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

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.

1987?

Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”

— Seth Klarman

Every week I read Steve Blumenthal’s from CMG Capital Management’s letter On My Radar . It is an excellent source of insights and research that Steve’s puts out every week. I really admire Steve’s style, wit and ideas on the investing universe. This week he mentions a quote attributed to Seth Klarman. We read everything we see from or about Seth as he is an investing legend. The quote struck us this morning as we had conversations this week with two of our more aggressive clients. They are able to be aggressive because they push risk to the back of their minds and continue to push forward and focus on returns. They have both been very aggressive from the financial crisis in 2008 until this week. Coincidentally, both have backed off and are ready to take some risk off of the table. Anecdotal I know, but, I think that it does have some value as it seems that a wide swath of investors now see the market as fully valued. What does that mean? The second level of thinking tells us that the market, since the market has been able to hold an overvalued level it could have further to run. Investors have pulled some risk out waiting for markets to take a breather and give them a better entry point – which it has not. They may be pulled back in chasing prices higher. We believe the animal spirits still have control of this market. The Trump Trade is still moving forward. Could tax reform be the “sell the news” event?

Our biggest question outside a possible shutdown of the federal government is about inflation. No. Not North Korea. I think the media has pumped that one enough. Inflation is our focus as some reports indicate this week that wage inflation could be on the rise. Wage inflation here in the United States could keep the Fed raising rates even while the economy sputters. The yield curve continues to flatten which is not good news for the banks while oil seems to be holding below $50 a barrel. Neither is good news for the market and bad news for both sectors makes it harder for the overall market to rally. These are two huge sectors; percentage wise, for the market and their reluctance to rally makes it harder for the tide to lift other boats. It also makes the any rally narrower with the likes of Apple, Amazon and Google leading the charge.

French election results give the ECB and the Federal Reserve the green light to be more aggressive in tightening policy. Inflation is also a green light. The pressure is building on central banks to take away the punchbowl. North Korea has the media on edge but I am more worried about inflation and Congress shutting down the government. The market is counting on movement out of Washington on healthcare and tax reform. It is never a good idea to count on Washington.

Mario Gabelli made mention that a 1987 style event could happen again this year. We do not disagree. We believe the market structure is in place that could lead to a moment where markets collapse quickly and temporarily. We believe it will be an opportunity for courageous investors but it will also be quick as there is a still a lot of money sloshing around markets looking for a home. Market is still stuck in its range for now between 2330 – 2400 on the S&P 500. Our thesis since last October has been a Triumph win followed by a 30% rally with an equivalent selloff in the fall of 2017 much like 1987. Markets are still following that script.

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 April 29, 2017 at 6:16 am  Leave a Comment  
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Behind Closed Doors

Known for being press shy, unlike some hedge fund managers, Paul Tudor Jones broke onto the trading scene with a splash by calling the 1987 stock market crash just days before it happened. So it was big news this week when it was revealed that Paul Tudor Jones, at a closed door meeting this week at Goldman Sachs, said that the Federal Reserve should be freaked out by this one “terrifying chart”. The chart in question also happens to be Warren Buffett’s primary indicator of market valuations.

It makes for good headlines but we have to say we have followed this chart for years and it is not a very good timing indicator for market corrections. However, it is a very good guide to the valuation of the overall market here in the Unites States and it is quite high. Market s can stay irrational longer than you can remain solvent betting against them. Interest rates and ballooning central bank balance sheets have pushed asset prices around the world to new heights.

It remains to be considered that IF central banks ever stop buying or, god forbid sell, then markets should fall. More interestingly, Jones said that the catalyst to the market fall will be risk parity funds. A bit inside baseball but, basically, the explosion of risk parity funds is based on momentum. The lower the market goes the more risk parity funds will have to sell equities. It could exacerbate any run in the market just as it has on the upside. :

We have been weighing in on the active vs. passive debate in the last few weeks as we feel that we have reached an inflection point. We believe that the pendulum swings back when it reaches extremes and we believe that we may be at that point. Think of it like this.  If everyone is invested 100% in ETF’s, passive management, then wouldn’t it be prudent to employ an active allocation to try and capture what inefficiencies are created by blindly piling en masse into ETF’s. We have been vocal proponents of the benefits of passive management but the pendulum may have swung too far and more evidence, however anecdotal, was presented this week by the creation of an ETF for ETF’s. An exchange traded fund (ETF) was created this week to follow the companies that benefit from the growth in the ETF industry. Maybe sometimes they do ring a bell. Time for more research.

Congress has been closed so the Trump Reflation obsession was put on hold and investors and media grew obsessed with geopolitical concerns with a spotlight on the French elections and North Korea.  Rates are falling while gold is rising. Fear is rising as some are reaching for protection in what is known as the “fear trade”. A move to gold and US Treasuries is the usually accompaniment when fear rises, especially in light of geopolitical concerns. Investors have become a bit more defensive. We may see rates rise and gold fall when Congress gets back into session.

Last 30 minutes of trading thesis has been inconclusive so far. No definitive pattern yet. Market seems to be in a consolidation pattern. The market seems to be digesting its gains and gathering itself before a move to a higher summit. Markets do not top out like this – spending weeks at a given level. The odds are that markets, when leaving a consolidation phase, move in the direction in which they came in.

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 April 22, 2017 at 6:31 am  Leave a Comment  
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WW III

We felt in recent months that there were too many people on the one side of the boat. That “side of the boat” was investors heavily shorting US Treasuries are they prepared for the Federal Reserve to raise rates three times this year. When everyone thinks something will happen you can almost guarantee that something else will. The 10 year closed Thursday at 2.23%. While a lot of because of geopolitical concerns and the long weekend we still think investors are too short Treasuries. This could be the last move lower in Treasuries as the short sellers’ force yields lower to cover their shorts and stop their pain. For now, we are still long duration but looking to sell into strength.

The last 30 minutes of trading have been abysmal. Four out of the last 5 trading sessions markets have moved lower in the last 30 minutes. We postulated in recent posts that the last 30 minutes are the “tell” in the market right now. Thursday was exacerbated by geopolitics and the long weekend so next week will help make that clue a bit more solid. Keep an eye on the last 30 minutes as that may be our best clue as to the near term direction of the market.

Strange week. Congress went out on Easter recess and so investors and the media began to focus (perhaps obsess) on geopolitics. The beneficiaries were the usual suspects of bonds and precious metals. Let’s see how things play out early next week if WW III doesn’t manage to break out this weekend.

Another week and another famous hedge fund manager is giving money back to clients. We take this as a sign that we could be at or near an inflection point. Jeff Ubben is a highly respected hedge fund manager and is giving 10% of his fund back to clients. He is finding it difficult to find value in this market. Valuations are stretched.

Active vs. Passive management has not been much of a fight over the last decade but we think that there are signs that perhaps we should be tilting more in the direction of adding some more active management. One of the headlines in Barron’s this weekend is “Can Humans Still Beat the Market”. This week Pennsylvania’s elected treasurer announced he is moving $1B from active to passive management to save $5M in fees. Treasurer Moving to Passive Investments

We know the argument all too well. Active is less predictable. It is more costly. It also pathetically tax inefficient. We think that investors have become too blind buying the whole market and there is room for active. The pendulum will swing back. We are diving back into researching for the active players who will outperform.

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.

Witches’ Brew

Witches’ Brew

It is a witch’s brew that the policymakers in Washington DC are conjuring up and it is not making things easy for investors or even other policymakers. While the 8 years since the financial crisis were filled with monetary policy band aids  Federal Reserve Governors never had to manage the delicate balancing act of the merger of their monetary policy with fiscal stimulus from the Legislative or Executive branches. Much as they begged for fiscal policy it never arrived. Now with Congress and the Executive branch controlled by the Republican Party, tax reform, deregulation and infrastructure are the current beltway buzzwords.

If you haven’t been keeping up with our Quarterly Letter  it is our current market view that the odds are high and rising that we are going to have some sort of error in monetary and/or fiscal policy. The combination of experimental central bank monetary policy and the Trump administration’s stated goals, if not enacted in concert, raise the risks that something is going to break. Those stated policy goals, while giving the Federal Reserve cover to raise rates, also make the Federal Reserve’s exit from their easy money polices of the last 8 years particularly tricky. To be frank their exit was never going to be easy.

This high wire act by the Federal Reserve entails anticipating the moves of not only the Trump Administration but also the response from Congress to the administration and as we have seen in the last few weeks, predicting Congress’ reaction may be the most difficult part. On March 15th the Federal Reserve chose to raise interest rates as the Trump Train was seemingly rolling down the tracks towards, first, healthcare reform and then quickly on to tax reform. But, only days later, markets were disappointed in the lack of policy movement on the ACA or “Obama Care” as it failed to even make it out of committee. This failure seemingly put the rest of the Trump agenda at risk. Federal Reserve policymakers are very carefully considering the policy that is coming out of the White House and Congress and plan to adjust monetary policy accordingly but they are having a difficult time predicting what will or won’t become law. They are now taking into account fiscal policy in their discussions for the first time in 8 years and predicting what the policymakers in Washington are going to do which is anything but easy money.

Any policy error could resolve itself in one of two ways. If central banks drag their feet and raise rates too slowly then that policy error could continue to incite animal spirits and drive equity valuations even higher, possibly to bubble like valuations. The Fed is also wary of the fact that there is a possibility that if they were to move too quickly they could throw cold water on the recovery especially if Trump’s fiscal and tax objectives get bogged down in the swamp – which we think they already have.  Equity prices could then fall sharply.

So far, it appears that the policymakers at the Federal Reserve are moving too slowly as the animal spirits of the market are winning. In fact, as the Federal Reserve was raising rates on March 15th they reinforced the narrative that they would move slowly with their statement in the press conference afterward. The Fed has been consistent in stating that 2% inflation was a target of theirs. In her latest press conference, Yellen made it clear that the 2% target is a target but not a “ceiling”. Additionally, her comment that the return to 2% inflation should be “sustained” made it clear to the market that the Fed is okay with letting the economy run “a little hot”.  The market took that as an all clear signal to take valuations higher as the Fed made it apparent that they are in no hurry to raise rates and slow this rally down.

Their statements made it seem as though the Federal Reserve feared a negative market reaction so much that they needed to couch the rate hike with statements to cushion the blow. That reinforced markets feeling that easy money is here to stay and markets turned higher in anticipation of a continuation of the easy money policy that we have seen over the last 8 years.

The market valuations are quite elevated at present time and rising. The possibility of a policy error by the Federal Reserve and/or the Trump Administration only looks to be increasing while increased valuations increase the repercussions of any policy mistake. We have been of the belief that a policy error could set the stage for a substantial rally and then fall ala 1987.

As the market has combined the clamor and excitement over deregulation and tax reform with a slow moving Fed you have room for the Animal Spirits to run as investor euphoria takes hold. A 30% run from the lows before Election Day, much like 1987,  (we are up 12.5% from Election Day as we write) would put us squarely in bubble territory as the S&P 500 would approach the 2750 area. A subsequent 30% retreat would bring us back to the 2000 area. Currently at 2360 on the S&P 500 one can see the potential for misstep by exiting one’s holdings completely and trying to time reentry. One solution is that we dial back risk as we see markets rising and adding risk when the risk premium is more in our favor. We will always make sure that we have the ability to buy when discounts come.

The Fed must attempt to act in concert with the President and his fiscal policy to avoid overheating or stalling the economy but good luck to them anticipating his next move and /or Congress’ reaction to his moves. Raising rates is not an exact science in the best of times but Washington DC seems hell-bent on confounding even the best informed or best intentioned.

Until Something Breaks

In his latest webcast last month, Jeff Gundlach, the current bond maven on Wall Street, made it clear that he expects the Federal Reserve to begin a campaign of sequential interest rate hikes until “something breaks”. In Cashin’s Comments last month, Arthur Cashin notes that David Rosenberg’s (Gluskin Sheff) research shows that since World War II, the Fed has embarked on 13 tightening cycles. Ten of those cycles led to recessions. While we do not see a recession on the horizon we do believe the Fed is behind the curve and may need to hike more aggressively than they would like. That will create imbalances throughout the system much like the sequential rates hikes in 1982, 1987, 1990, 1997 and 2007. The crises that raged in the aftermath of those rate hike cycles ranged from the Latin American debt crisis in 1982 to the S&L crisis in 1990 to the subprime debt crisis of 2007.

The rate hike on March 15th is the third rate rise of this cycle with the stated goal of two more rate hikes in 2017.  The old Wall Street adage is 3 hikes and a stumble. Wall Street lore suggests that the third rate hike is when markets start to falter. The Fed is damned if they do and damned if they don’t. It’s a guessing game with imperfect information. This is the kind of decision a trader makes and not the kind that academics make well.

The reality is that the Fed may be so far behind the curve that this rate hike, the third of this cycle or even the fourth rate hike doesn’t affect the market but sooner or later the Fed will hike and something will break. They are academics and they do not anticipate change. It’s like driving using the rear view mirror (h/t BR). The data that they rely on is from the past and doesn’t show when the trend has changed. They will hike until something breaks.

 Bumps in the Road

What other bumps in the road do we see? We are watching very closely not only the developments in Washington but also in Riyadh. The oil market may be our best hint as to what is going to happen next. The oil market and the high yield bond market are very closely related as much of the loans in the high yield sector have gone to oil related operations. Any falter in the price of oil could have further consequences and ripple effects across the economy. Oil has hit it own speed bump as West Texas Crude slipped below the psychologically important $50 a barrel level. As so goes oil so goes the economy and the stock market. If oil slips, so may stocks. High yield bonds may be our canary in the coalmine here.

Our biggest worry over the next several months is the impending Debt Ceiling negotiations in Washington. The Freedom Caucus is a group of Republicans that skewered the Obama Care replace and repeal. They have become a very powerful group in Washington all of a sudden. They are no fans of raising the debt ceiling. This could turn into a showdown with massive repercussions. In June of 2011, February of 2013 and October of 2015 we saw circumstances where we have been faced with debt ceiling negotiations. Two out of those three events saw markets move lower in response. It is about time that Congress took away the uncertainty surrounding this biannual discussion. Let’s see how far they push things this time. Warren Buffett once said that he did not like to invest when there was possible government intervention and over regulation in a business. We are all invested in what comes out of Washington DC now.

In the investing game it is worthwhile to follow retail investor money flows. It is the retail investor that is usually late to the game and the marginal buyer at tops in the market and a seller at the lows.  Retail investors are currently pouring money into equity ETF’s as shown by the fact that the S&P 500 ETF (SPY) had its largest inflow since 2014 last month and its second largest daily inflow since 2011. We also watch closely the movements of corporate insiders. While we place a premium on insider buying, insider selling should be taken with a grain of salt. (There are many reasons to sell. There is only one reason to buy.)As per a report from CNBC company insiders are dumping stock into the marketplace at accelerated rates.

By way of Arthur Cashin, we see that according to Jason Goepfert at SentimenTrader hedge funds are also pulling back.

“After reaching one of their most-exposed levels in 15 years, hedge funds have started to lessen their positions in stocks. There have been three other times that they were as exposed as they were in the past month, and when they started to pull back and volatility rose, stocks fell hard, fast.” 3/24/17

Valuations are quite extended and perhaps rate hikes will bring things gently back to earth. Much is being made of the idea that there seems to be a global upturn in economies. The global upturn and Trump’s policies could provide more cover for the Fed to raise rates to try and cool valuations off. You have to remember that they are not the only central bank adding fuel to the fire. Japan, China and Europe are all doing the same.

Heisenberg Uncertainty Principle

There is always something to worry about but currently there are too many investors on the same side of the boat. One of the best ways to generate alpha or excess returns in the last 8 years has been to BTD. Buy the dip. It is actually BTFD but we are too polite to write that. Traders have been conditioned over the last 8 years to buy every pullback in pricing.

The Heisenberg Uncertainty Principle, from German physicist Werner Heisenberg, shows us that simply the act of observation affects the particle being observed. (The original version of the uncertainty principle appeared in a 1927 paper by Werner Heisenberg, a German physicist, titled “On the Perceptual Content of Quantum Theoretical Kinematics and Mechanics”.) In investing, we see the Uncertainly Principle at work when the market observes an outperforming strategy, subsequently, that strategy will then begin to lose its outperformance.  That is why you see investors all on the same side of the boat. When investors observe an outperforming strategy they pile on. All those flocking to the same side of the boat decrease the odds of outperforming and raise the risks of underperforming. When you find the key to the market they change the locks.

Our job is not to predict the future but to manage risk for our clients. History tells us that future returns are, in good part, reliant on starting at low valuations and that when beginning at high valuations we see lower than average returns. It is prudent, at this juncture, given that valuations are currently in the highest 10% in history, that we take some risk off of the table for our more risk averse clients. We will continue to press our bets for our more aggressive clients but we have one hand on the brake.

A lot depends on the perception of the Trump Administration post vote. Is tax reform coming or has the swamp won? We believe that the last 30 minutes of trading each day will give us clues as to what managed strategies are influencing the market and whether the big intuitions are leaving the market.  We still think that this could be the last 10% of a move that started in the post 2008 crisis period as valuations are rich. It is awfully hard to predict time and direction but we believe that given historically high valuations it is prudent to trim down risk (and accept possibly lower returns) until the risk premiums are more in our favor. We believe that a move lower at this juncture will be met with buyers down 5-8% from the highs while history tells us that the old highs will be approached once again. That is when the real decisions will need to be made.

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

 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

Published in: on April 8, 2017 at 10:59 am  Leave a Comment  

Did the Swamp Win?

Trump Care, Obama Care or tax reform? It was really all about tax reform and not the Affordable Care Act (ACA aka Obama Care).  The shelving of the vote for reforming ACA may lead to markets being buoyed by the fact that Trump will now move on to tax reform.  It was never really about the ACA replace and repeal for Wall Street. The market was just looking for this to pass so that the administration could then move on to tax reform. A shelving of replace and repeal allows the administration to move on to tax reform as the ACA dies a slow death. Remember a yes vote would have just sent it to the Senate where it would have moved at a snail’s pace distracting the administration, delaying tax reform and distracting markets.

Lots of warning signs. The technical aspects of the market are growing less positive. Markets had reached such overbought levels that the next thought from market analysts is to say that there is negative divergence. In English please. Suffice to say that just means that the next up move will not have the same firepower as the last one and market participants could get nervous and pare back longs. By way of Arthur Cashin, we see that according to Jason Goepfert at SentimenTrader hedge funds are pulling back.

“After reaching one of their most-exposed levels in 15 years, hedge funds have started to lessen their positions in stocks. There have been three other times that they were as exposed as they were in the past month, and when they started to pull back and volatility rose, stocks fell hard, fast.” 3/24/17

 Ally Financial and Ford Motors both warned about a drop-off in the car market here in the US. Ally Financial slashed their earnings outlook as they see the worst used car prices in 20 years. Make sense. Have you bought a new car lately? It’s not a car. It’s a computer and we all know Moore’s Law and how our technology gets outdated quickly. Used cars are not nearly as safe as a car made today and the technology is improving rapidly. Pretty soon insurance companies are going to catch on that it is much less likely that a new car is going to get into an accident than a used car without all the latest safety technology. Morgan Stanley came out this week and said that the latest offering from Tesla will be 90% safer than cars currently on the road. Buying a used car in the past seemed frugal. Now it seems almost reckless. Used car prices are dropping. Since the crisis, banks have been extending the length of car loans from 3 years to 7 in some cases. Oops! The banks may have done it again!

This week the market actually saw a daily decline of over 1%! That is the daily decline of 1% or more since October of last year. Think we were overdue?  Turns out that Eric Mindich, of Goldman Sachs fame is getting out of the hedge fund business. That may have helped contribute to the weakness we saw this week. Mindich’s Eton Park hedge fund ran over $12 billion at its peak. It is now returning money to investors and market players may have shorted stocks in front of the liquidation of their positions. A time honored Wall Street tradition of making money off of someone else’s demise.

RBC’s Charlie McElliggott has been proffering some interesting analysis by way of zero hedge. Click on the link for more detail. Careful it gets a little wonky. Suffice to say that Mr. McElliggott seems to be saying that the more volatile things get the lower the market will go. If things stay quiet the market will continue to levitate. Keep an eye on the last 30 minutes of trading as they are the “tell”. He also goes on to say that more and more money is going into the same trades and strategies. Same side of the boat theory. Never ends well when everyone is leaning the same way. We couldn’t agree more with McElliggott and his team at RBC.

A lot depends on the perception of the Trump Administration post vote. Is tax reform coming or has the swamp won? Keep an eye on the last 30 minutes of trading.  We still think that this could be the last 10%. Markets are a touch oversold but caution must still be paid.  We are pressing the bets with our more aggressive clients but pulling back for our more risk averse. A move lower at this juncture should be met with buyers down 5-8% from the highs while history tells us that the old highs will be approached again. That is when the real decisions will need to be made.

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.

This House is Rocking

Janet Yellen seems petrified of scaring the market. We have news for her. At some point she will. It’s her job to take away the punchbowl when the party gets started and this house is rocking. The Federal Reserve uptick in interest rates, while widely telegraphed, still managed to surprise markets by it being couched in the most dovish way possible.

How did Janet Yellen do that? The Fed has been consistent in stating that 2% inflation was a target of theirs. In her latest press conference, Yellen made it clear that the 2% target is a target but not a “ceiling”. Additionally, her comment that the return to 2% inflation should be “sustained” made it clear to the market that the Fed is okay with letting the economy run a little hot.  Janet Yellen may have to talk back the market’s reaction this week from her dovish rate hike. The market reacted positively which we expected but we did not expect the extent of that positive reaction.

surprisingly, financial markets took the meeting as a large dovish surprise—the third-largest at an FOMC meeting since 2000 outside the financial crisis, based on the co-movement of different asset prices.” – Goldman’s Jan Hatzius 3/15/17

The risk is that the market and economy may overheat. There is also a risk that the Fed could throw cold water on it if Trump’s fiscal and tax objectives get bogged down in the swap which we think they already have. The Fed is damned if they do and damned if they don’t. It’s a guessing game with imperfect information. The kind of decision a trader makes and not the kind that academics make well. The time is ripe for a policy error. Now whether that error takes the market higher or lower depends on the action of the Fed. Right now by portraying this rate hike as dovishly as they did the animal spirits in the market are taking things higher. Next week should tell us a lot more about how the market feels.

The Fed is boxed in. A canary in the coalmine, small-caps keep sagging. The Russell 2000 dipped into negative year-to-date territory on Tuesday morning. There was nary a mention of the debt ceiling that was reached this week. This is going to be a problem and, possibly, with the rancor in DC, it could become THE problem. The Treasury only has about one month’s cash on hand. Less than Google or Apple have on their books.

Yellen raised rates but couched it so dovishly the market rallied. She is afraid of a negative market reaction. She should be afraid of a positive market reaction as the real reason she raised rates was to cool off the market. Market seems ready to continue its running with the bulls as we suspected. This could be the last 10%. Caution. We are pressing the bets with our more aggressive clients but pulling back for our more risk averse.

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 March 18, 2017 at 9:00 am  Leave a Comment  
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