Priceless Investing Advice

Being in the investment arena our job is mostly about gathering information. Reading. Lots and lots of reading. Corporate reports, sell side research, blogs, websites, financial journals, and the like. We have our favorite sources and investors.  If you have read our notes for any length of time you know that we read anything that we can get our hands on that Howard Marks has written. Mr. Marks’ latest note is out this week. Marks doesn’t write every week or even on a consistent basis but when he writes he has something to say and he envelopes everything he writes with priceless investing wisdom. If you are a serious investor you must read the whole piece. I am having trouble just boiling it down to a few well turned phrases or sound bites but here goes.

 As I explained on CNBC, there are two things I would never say when referring to the market: “get out” and “it’s time.”  I’m not that smart, and I’m never that sure. 

 “Investing is not black or white, in or out, risky or safe.”  The key word is “calibrate.”  The amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive. 

 If it’s true, as I believe, that (a) the easy money in this cycle has been made, (b) the world is a risky place, and (c) securities are priced high, then people should probably be taking less risk today than they did three, five or seven years ago.  Not “out,” but “less risk” and “more caution.”

Marks mentions that he is not referring to this market as a “bubble”. He is probably right. There are no signs of euphoria (other than bit coin) but investors are begrudgingly going along with higher prices. It is more of a FOMO (Fear of Missing Out) mentality. Valuations are high and rising and “getting out” at the top is a pipe dream. Rather than jump in and jump out of the market we seek to re-calibrate our investment allocation in regards to the risk premium in the market. If prices are high then we wish to take some risk of the table. We can put our money into investments that have less risk or place them with outside managers with a history of performing well in riskier markets. We can also choose to place more of our assets in cash which is essentially a call option on risk. We, like Marks, continue to proceed but with caution. “Calling a top” and “getting out” are a Fool’s Errand but lessening our risk in light of historical valuations is a prudent thing to do.   

In regards to risky behavior we call your attention to something that we have seen for some time, over and over again and it costs investors huge sums of money. This time around it is the sale of “Cat Bonds” to the small investor. Once the province of big money center banks and off shore insurance companies “Cat Bonds” are catastrophe bonds sold by large reinsurance companies. The short story is you can make high yield returns by investing in bonds which insure against wind damage, hurricanes, earthquakes and other catastrophic events. Suffice to say that those investors after several years of decent returns will return to work on Monday with a lot less digits in those accounts. Those investors will be wiped out completely if Irma has her way with Florida this weekend. How do you spot these enemies to your portfolio the next time? It is easy. If someone promises you an above average yield in a product that is unlisted (it does not trade on an exchange) with high management fees – run, do not walk away from this investment advisor. I have seen too many of these investments in investor’s portfolios in my time. The advisor ends up with his management fees and the client ends up with the goose egg.

 When the pressure is on we like to have what we term “adults” in the room. The “adults” are not only the smartest people in the room but they are people who know how and when to make a decision. Stanley Fischer is one of those “adults”. Dr Fischer, former professor at MIT, vice chairman of CitiGroup, and chief economist of the World Bank, and former Governor of the Bank of Israel, resigned his position as vice chair of the Federal Reserve. Fischer played the role of intelligent hawk who we felt comfortable leaving in charge of the store. As this critical time approaches of the Fed removing stimulus his absence alone makes us less confident in the “adults” left in the room. In one of his last public speeches as part of the Federal Reserve Dr Fischer warned about historically high asset valuations.


Let me conclude my assessment of current financial stability conditions with a discussion of asset valuation pressures… In equity markets, price-to-earnings ratios now stand in the top quintiles of their historical distributions, while corporate bond spreads are near their post-crisis lows. …

The general rise in valuation pressures may be partly explained by a generally brighter economic outlook, but there are signs that risk appetite increased as well…So far, the evidently high risk appetite has not lead to increased leverage across the financial system, but close monitoring is warranted.

https://www.federalreserve.gov/newsevents/speech/fischer20170627a.htm

West Texas Crude has had some wild moves post Hurricane Harvey but is still stuck between $45-50 a barrel. The safe havens benefited this week as gold has sufficiently punched through $1300 making that area now support.  The ten year Treasury which had been stuck between 2.15% and 2.40% since April finished the week at 2.05% which could augur a price movement down into the 1.75-1.85% area. The move is on into the safe havens while stocks mystically continue to hold their gains and their range between 2420-2480. While the caution signs are there the market is still firmly in an uptrend. A punch through 2480 on the S&P 500 could give the bulls room to run. The rally off of the lows has been anything but active. A low volume run up doesn’t bring with it much conviction but the animal spirits could take over regardless with a swift punch through 2480. The pressure is building.

 Harvey was the story last week. This week it’s IRMA. Best of luck to all our friends and family in Florida. Hold on tight.

 

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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/ .

 

 

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

 

 

 

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Pressure is Building and Hurricane Relief Homework

The markets perceived safe havens of gold and the US Treasuries continue to rally. The yield on the 10 year is back to flirting with the 2% level. Gold is trying to break through $1300 an ounce and was outperforming the S&P 500 for 2017. Those are not exactly confidence builders for stock investors. Those are flight to safety trades.

 While lower interest rates have been a hallmark of this bull market, used to justify virtually any valuation, the lens through which investors view them is nuanced. Too low and they start to suggest economic stress.

After rallying in sync for much of 2017, bonds and stocks have become disjointed as economic data misses expectations for the third straight month. The one-month correlation between the S&P 500 and the Bloomberg Barclays Global Aggregate Bond Index is at the lowest since April, with the S&P 500 flat lining since its Aug. 7 high, as 10-year yields dropped 11 basis points.

We grown concerned when the bond market looks anxious and the stock market ignores it but this is not your father’s stock market. This market has shrugged off thermonuclear war fears with North Korea, Presidential special prosecutors, the firing of a sitting FBI Director, a potential debt ceiling debate/default, rising interest rates and the expected shrinking of the Federal Reserve balance sheet.

The S&P 500 rallied off of its lows of 2430 to close the week at 2476. That brings us back to the resistance levels that we have been talking about since mid July. The market has rebounded quite quickly. What is interesting is that investors have been seemingly unanimous in calling for a market setback in the August – October timeframe. If that selloff does not come we may that melt up we have been talking about (ala 1987). Fund managers are under invested and do not wish to disappoint clients come year end. Time is money. A punch through 2480 on the S&P 500 could give the bulls room to run. The rally off of the lows of last week has been anything but active. A low volume run up doesn’t bring with it much conviction but the animal spirits could take over regardless with a swift punch through 2480.

Hurricane Harvey may be helping the stock market by taking a debt ceiling fight off of the table but you wouldn’t know it by looking at the short term bond market. The calendar around when we suspect the government will run out of money has grown quite active and its pricing is indicating that the bond market doesn’t have that much faith in Washington.

Since 1950, August and September are the worst performing months for the S&P 500. However, in the last ten years it is January and June that have taken the mantle of worst performing months. While the caution signs are there the market is still firmly in an uptrend. Support on the S&P 500 is very strong at its 100 Day Moving Average (DMA) and the 2420-2400 area is support for now. Trading desks have been understaffed since Memorial Day and markets have gone nowhere. Oil is stuck between $45-50 a barrel while gold struggles with $1300. The S&P 500 is range bound for now between 2420-2480. The ten year Treasury has been stuck between 2.1% and 2.40% since April. The pressure is building. With staff back in town things may get very interesting very quickly.

Harvey may bring some shortages up and down the east coast. Fill up before you leave the house. Have a great Holiday weekend!

Our old friends at Charity Navigator have done the homework for you and listed a few highly rated organizations for Hurricane Harvey relief. You can see more at their link below.

If you’re looking for a local charity to support in the wake of Hurricane Harvey please consider Houston SPCAHouston Humane SocietyHouston Food BankFood Bank of Corpus Christi, or San Antonio Humane Society. These highly-rated organizations are located in the most-affected areas and are providing support to individuals and animals.

– Charity Navigator

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/ .

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.

Caution Flags

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

“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.”- Janet Yellen Jackson Hole 8/25/17

In Janet Yellen’s speech this week at Jackson Hole she brokers the subject of market structure and her anxieties surrounding the structural integrity of the market given additional stress.  Will current market structure provide the liquidity needed given a stressful event? We think that it will not and a temporary condition will be created consisting of a lack of liquidity will happen for a time. The pessimist sees what would be a very scary moment if market structure lets us down in the next stressful period. What we see on the horizon is a market structure that we think will fail and will create a big opportunity. Market structure. We see the risk as real and evidently we are not the only one.

Dow Theory is the long running thesis that if Dow Jones Industrials are hitting new highs then its brethren in the Dow Jones Transports should be hitting highs as well. The Industrials make the goods and the Transports ship the goods. So if the one is doing well shouldn’t the other? We are not the only one concerned. By way of Arthur Cashin, comes Jason Goepfert recent notes on the topic.

Jason Goepfert, the resident sage at SentimenTrader noted the recent wide divergence between the Dow Industrial and Dow Transports. He recalls that prior similar divergences have rarely been resolved in a bullish fashion. Here’s a bit of what he wrote: The Dow indexes are out of gear. The Dow Transportation Average continues to badly lag its brother index, the Dow Industrial Average. The Transports are not only below their 200-day average, they just dropped to a fresh multi-month low. Yet the Industrials are more than 5% above their own 200-day average, a divergence which has tended to resolve to the downside for both indexes, especially in the shorter-term.

While we have the caution flag up we are intrigued by how many analysts and investors are calling for a downturn. When everyone expects something to happen something else usually does. From Bloomberg this week comes notes from Morgan Stanley, HSBC and Citigroup that markets long term relationships are breaking down and signaling that a correction is in store.

Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop.

“Equities have become less correlated with FX, FX has become less correlated with rates, and everything has become less sensitive to oil,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote in a note published Tuesday.

https://www.bloomberg.com/news/articles/2017-08-22/wall-street-banks-warn-winter-is-coming-as-business-cycle-peaks

At the beginning of this week stocks were very oversold and due for a bounce. Equities were so oversold, in fact, that we did buy some equities for underinvested and new clients. The S&P is now approaching very important resistance levels at 2450 and again at 2475. 2475 is THE resistance level that the market has been struggling with since mid July. The market looks tired here and the seasonality is not in its favor with September and the October debt ceiling approaching. A failure at 2475 could give the bears confidence. The S&P 500 saw support at its 100 Day Moving Average (DMA) and the 2420-2400 area is support for now. The next support is the 200 DMA at 2350 which is down about 3.7% from here. If markets fell to that level that would be a 5.5% drop from the all time highs, certainly, not a major crisis. However, the bulls would need to hold the 2350 level or then the bears are in charge. We are still concerned that while the S&P 500 has held in there the Russell 2000 is struggling. That coupled with high valuations and a negative Dow Theory signal has us sending up caution flags.

 

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/ .

 

 

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.

Fear and Greed

While most of America seemed to be mired in statue controversies and rumored and real resignations we choose to focus on making money for our clients. Our focus was on the FOMC Minutes that came out this week. We think that it has real clues as to policy and market direction (i.e. making money). Here, as follows, is the garbled Fed Speak hidden deep in the minutes which we will interpret for you.

This overall assessment incorporated the staff’s judgment that, since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets…

 recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.

 According to one view, the easing of financial conditions meant that the economic effects of the Committee’s actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.

We interpret the committee’s thoughts as, while the committee likes higher stock prices, a further rise in stocks isn’t going to help much. In fact, higher stock prices may actually increase risk. No one seems to be noticing that risk is elevated and hedging accordingly which only heightens risk even further. And by the way, our (the FOMC) tighter policies (raising rates) haven’t really done much and we are going to need to tighten policy much more than we thought. Was that a warning shot across the bow? The Fed doesn’t want stocks to go up much more and tighter policy is coming.

As always, from Arthur Cashin and his sources, comes a very interesting note about the technical aspects of the market. We study technicals because it gives us insight to the psychology of the market. The numbers show where Fear and Greed reside. After Jason’s note came out earlier this week markets were repelled by the 2475 area and fell 2% from that level. Here is Jason’s note.

While they closed within hailing distance of the day’s highs, the session had some very odd aspects. Here’s what the sharp-eyed Jason Goepfert of SentimenTrader noted in his report. More lows. Despite a 1% surge in the S&P 500, its best gain in months, and being within sight of an all-time high, there were more combined new 52-week lows than 52-week highs on the NYSE and Nasdaq exchanges. This is highly abnormal. Since 1965, it has only been seen a handful of days in 1998, 1999, 2000, and 2015 -Cashin’s Comments 8/15/17

NY Federal Reserve President Dudley sees chances of a Fed rate hike higher than the market is currently forecasting in December. Chances for that rate hike are now close to 50% and rising. The market continues to reject the 2475 area on the S&P 500. As a resistance area it is growing in its importance. The bulls still have the ball but they need to get their act together.

The S&P 500 is at its 100 Day Moving Average (DMA) and the 2420-2400 area is support for now. The next support is the 200 DMA at 2350 which is down about 3% from here. If markets fell to that level that would be a 5.5% drop from the all time highs, certainly, not a major crisis. However, the bulls would need to hold the 2350 or then the bears are in charge. The S&P 500 is 2.5% from its highs while the Russell 2000 is down more than 6%. The broader market indicator failed to hold its 200 DMA this week. Not a healthy sign. Always have some dry powder on hand.

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.

 

 

 

Fall Is In The Air

As much consternation was shown this week the S&P 500 was only down 1.4%. While markets have slowly marched ever skyward since 2015, lulling investors into complacency, market internals seem to be breaking down of late and just in time for the traditionally weak fall season. Our friends over at Lucena Research are at the forefront of applying Artificial Intelligence and Machine Learning to investment decision making. Their note to us on Monday researched some market internals as they dug up some dirt on the recent divergence of the S&P 500 and the Dow Jones Industrials. Their research came up with 39 instances of this type of divergence in the last 17 years. According to their research, over the next year the S&P 500’s average drawdown was 8.5% with the bottom of the expected bearish move coming within 7 months on average.  Here is the link to their note. Brilliant stuff.

http://lucenaresearch.com/wp-content/themes/lucena-theme/predictions/8-7-17.html

Also showing the internal weakness of the market is that the market has grown increasingly narrow in its ascent. An article from CNBC this week shows that 20% of the S&P 500 is in correction territory. A “correction” is generally accepted to be when a stock has retreated more than 10% from its high. 200 of the 500 stocks in the S&P 500 are in correction territory including Amazon, General Electric and Exxon. The S&P 500 is up over 9% in 2017. It shows how narrow the rally in stocks has become. The article goes on to note that less than 60% of the Russell 3000 is trading above its 200 day moving average (DMA). The 200 DMA is the dividing line between being long term bullish on a stock and long term bearish. The market’s strength is slipping.

Things are starting to get interesting. The market rejected 2475 on the S&P 500 as that area still holds as resistance. The bulls need to get back in gear. We closed the most eventful week in months in the middle of our range. We still see support at 2400. The likelihood of an actual shooting war in the Korean Peninsula is very low but we have never seen diplomacy by Twitter. The bulls need to hold 2400. As a side note we do find it refreshing that the market is actually taking geopolitics into account. The biggest contributor to the downside move this week may have been the short volatility trade. Shorting volatility has worked for years but we have been noting that it is a crowded trade and traders were due to get burned. Those traders looking for cover may have made an outsized contribution to the swings in the market this week. Might be time to take some chips off of the table if you haven’t already.

 

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.

Tops and Bottoms

 

More signs of top and bottoms. Andy Hall, legendary oil trader, otherwise known as “God” in the oil pits has finally thrown in the towel. According to Bloomberg, the long time oil bull was forced to liquidate his main hedge fund this week. The slump in oil has worn his investor’s patience thin as his main fund was down 30% in the first half of 2017. His latest letter stated that OPEC had lost control of the market and oil is stuck at $50 a barrel.

Tesla has had a similar effect on short sellers. According to S3 Partners Research short sellers have lost over $3.5 billion in the last 18 months trying to pick the top in Elon Musk’s Tesla. The massively overvalued stock has short sellers running for cover after its latest earnings release. A short squeeze has helped Tesla’s shares reach new heights. Short sellers are investors looking to profit from the fall of a security. They borrow stock and sell it hoping to see the stock fall in price when they can then buy it back at a lower level and profit from its fall. Tesla’s release of its latest earnings has short sellers competing with each other to cover their short and cut their losses.

Each of the above is noteworthy, in that, they show that moves have become extreme. The closing of funds show market bottoms. The closing of short positions show market tops. Keep an eye on oil and high valuation stocks.

We received word from different sources this week that cash allocations for investors are at historically low levels. The American Association of Individual Investors (AAII) reported in its latest survey that individuals are holding their lowest cash levels since 2000 and the end of the Internet Bubble. Bank of America reported in a survey of its High Net Worth clients that they too are at all time low levels of cash not seen since 2007. 2007 is another year that conjures up rather poor images for investors. We have high cash allocations in our clients’ accounts due to high valuation levels but from a statistical point of view we are stashing more of it into MM funds and short term bond funds as yields rise and cash savings rates come off of zero interest rates. This could be an indicator of a frothy market or just a statistical anomaly.

Based on Thursday night’s close the S&P 500 11 day closing range is the lowest in its 90 year history. 90 years! That’s a long time. Even with the news of North Korean missile launches and a Grand jury investigation of the sitting US President’s campaign the stock market has grown stagnant. The market has grown increasingly narrow in its ascent. The Dow Jones Industrials are up 2000 points so far in 2017. Over half of those gains have been provided by just 3 stocks – Bowing, McDonalds and Apple. While another Dow component, GE, is down 20% from its highs and entering its own bear market.

You may start to hear more about Dow Theory in the coming days. Dow Theory says that the Industrials and Transports need to move in concert. Transports are down 5% from their highs and trying to hold its 200 Day Moving Average while Industrials are hitting new all time highs. There is also a divergence between the Dow and the broader market as exemplified by the Russell 2000’s struggle to hold its 50 DMA while the Dow hits new highs. The signs of a top are showing but the trading algorithms will not let the market down. Algos flaw is that they promote virtuous and vicious cycles.  The higher the market goes the more algos buy. The more the market goes down the more they need to sell and the fewer bids there are.

Yet Two More Cautions – Jason Goepfert of SentimenTrader noted yet two more cautionary precedents. Wednesday marked the 7th straight daily gain for the Dow, and of course, a multi-year high. Remarkably, this is the 4th time in the past 200 days that the Dow has managed a streak like this, the most in its history. The last time it managed even three such streaks was in the summer of 1987, which led to a bit of trouble a couple of months later

8/3/17 Cashin’s Comments

Hat tip to Arthur Cashin for the above research from the very insightful Jason Goepfert. We couldn’t resist mentioning 1987 again. Sorry for the length of the blog this week. Things are starting to get interesting. We are dropping our oldest off at college this weekend. Wish us luck. Time flies. For now, the market refuses to break through resistance at 2475 on the S&P 500. We still see support at 2400. If they break through resistance then we are off to a new range of 2475-2550. The path of least resistance is higher for now but September/October loom.

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.

One Classic Mistake

 We were fortunate enough to find the time to read Howard Marks’ latest letter. As a refresher Howard Marks is the person that Warren Buffett once said that anything that Howard writes goes straight to the top of his reading list. While Marks’ letter is probably his longest in years it may also be one of his best. It is FULL of investing gems that should be made required reading at any graduate program. Here are some highlights but do yourself a favor and give it a read. The link is below. It is long but a very easy read and well worth the time. Marks opines that this time seems very similar to 2000 and 2007. It is hard to disagree.

Latest memo from Howard Marks: There They Go Again… Again

 Here’s how I summed up on this topic in “There They Go Again” (May 2005):

You want to take risk when others are fleeing from it, not when they’re competing with you to do so.

This combination of elements presents today’s investors with a highly challenging environment. The result is a world in which assets have appreciated significantly, risk aversion is low, and propositions are accepted that would be questioned if investors were more wary.

 Not a nonsensical bubble – just high and therefore risky.

 The usual consequences of the conditions I describe – like an eventual increase in risk aversion – should happen, but they don’t have to happen.

And they certainly don’t have to happen soon.

I’m never sure of my market observations.

As a natural worrier, I tend to be early with warnings

the easy money in this cycle has been made

 Oaktree will continue to follow its 2012 mantra: “move forward, but with caution” – and, given today’s conditions, with even more caution than in the recent past.  If one is going to invest at times like this, investment professionalism – knowing how to bear risk intelligently, striving for return while keeping an eagle-eye on the potential adverse consequences – is the absolute sine qua non.

But there is one course of action – one classic mistake – that I most strongly feel is wrong: reaching for return.

 The basic proposition is simple: Investors make the most and the safest money when they do things other people don’t want to do. 

 By way of Arthur Cashin comes research from Keene Little of Option Investor. Little emphasizes that while earnings for US companies have increased 265% since 2009, which is in line with the 271% spike in the S&P 500, sales for those companies have increased only 32%!!! How is that possible? Corporate buybacks. Buybacks reduce the number of shares outstanding which pumps up Earnings Per Share (and corporate executives pockets). Our blog last week pointed out one of the unintended consequences of QE and too low interest rates has been the fear of investing in plant and equipment. Why build the factory when the economy is in the doldrums and interest rates are going nowhere? There was no impetus to take a chance and build. Corporations were incentivized to borrow at all time low rates and take the low risk approach of buying back their own stock. Little goes on to ask who will do the buying when corporations stop?

Here is a quote from our blog last week.

The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen. 

Dr. Ben Hunt Epsilon Theory

There were more research notes out this week from some of the quants on Wall Street and the subject is, again, volatility. This is a crowded trade. It feels as though this trade is building and building. This trade has the potential to crush markets as it will feed a vicious spiral. If volatility were to increase quickly then funds will be forced to sell and de-lever. That selling and deleveraging will force more into the market to be sellers as buyers step aside. It was compared to portfolio insurance this week by Marko Kolanovic at JP Morgan. Just a reminder, it was portfolio insurance that was blamed for the 1987 stock market crash that took the market down 20% in one day. 1987. There is that year again.

We are in the midst of our first extended period since the financial crisis began that the market is rallying while the Fed’s balance sheet is holding steady. You can see in the chart below courtesy of BAC that in the 2014-16 period the market treaded water while the Fed’s balance sheet did the same. Now the market is leaving the central bank balance sheet in the dust. Right when the Fed’s are talking about decreasing the balance sheet.

September looms large as the tapering of the Fed’s balance sheet looks to be still on schedule to start after the FOMC meeting on September 20th. The next ECB meeting is September 7th with the Bank of Japan stepping to the plate on September 21st. Shale companies like Anadarko are slashing CAPEX. The growth in rigs seems to have stabilized. Could that be an oil bottom? West Texas Crude up 8.5% for the week to close just below $50 a barrel. Biggest week of 2017.

The debt ceiling is scheduled to be hit in mid October. For now we see support at 2400 on the S&P 500 with 2475 providing resistance. If they break through resistance then we are off to a new range of 2475-2550. The path of least resistance is higher for now but September/October loom.

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.

Anyone Have a Match?

The debt ceiling is coming! The debt ceiling is coming! Not quite Paul Revere but the Treasury market is showing signs that investors are getting concerned about the debt ceiling being reached in mid October as the CBO has warned. If Republicans can’t get a bill through that they have been working on for seven years how will they get the debt ceiling passed through the most polarized congress in history? Months ago we were looking at sweeping changes with the Republicans controlling both houses. Now, instead of tax reform, we are looking at a government shutdown. For once, gridlock in DC may not be so good.

We have been postulating for years that the reason that the economy is not doing well is that interest rates are too low and that there was no threat that interest rates would go higher. Think about it. There has been no incentive to borrow and buy a car, a home or invest in plant and factory. We can “put it off until next year” because we aren’t sure about the economy and rates aren’t going anywhere. We came across this blog post from Epsilon Theory and Dr. Ben Hunt. It is not the common thinking but that is usually where the answer lies.

The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen. Why in the world would management take the risk — and it’s definitely a risk — of investing for real growth when they are so awash in easy money that they can beat their earnings guidance with a risk-free stock buyback?

(As the Fed slowly raises rates) It will force companies to take on more risk. It will force companies to invest more in plant and equipment and technology. It will force companies to pay up for the skilled workers they need.

In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory.

My view: as the tide of QE goes out, the tide of inflation comes in. And the more that the QE tide recedes, the more inflation comes in.

Dr. Ben Hunt Epsilon Theory 

I agree with Dr Hunt that at some point central bankers may be asking – Why is inflation accelerating as we raise rates? How come we cannot contain inflation? In talking to business leaders over the last several years we have not seen many talking up their industry as “hitting on all cylinders”. Last month we spent some time with a leader in the medical device field which he says is booming. Industry players are borrowing for plant and equipment for the first time in years. Combine some tax reform with higher rates and BINGO! That joint is jumping. Central bankers have been pouring gasoline on the pyre for years with no effect. Pushing on a string. Higher rates may be the match and with too much gasoline on the fire inflation may be the result.

Markets have been quiet. A little too quiet. We have read story after story about the volatility trade and how volatility has to spike higher to flaunt this overcrowded trade. We agree but this year has been very quiet. How quiet? This year has seen its largest drawdown of only 2.8% on the S&P 500. That is a far cry from the 14% average. According to LPL, the S&P 500 has not had a drawdown of 5% or more in a calendar year only 5 times in the last 60 years and it has not happened in 30 years. NASDAQ was up 11 straight days until Friday. According to LPL’s Ryan Detrick this has happened 21 times since 1980. The next month on average for the NASDAQ is up 2.6% with 16 of those 21 being positive months.

The tapering of the Fed’s balance sheet looks to be still on schedule to start in September. The debt ceiling is scheduled to be hit in mid October. Short interest is back down to levels last seen in the second quarter of 2007 at the market peak. Equities are at the top of their new range on the S&P 500. For now we see support at 2400 on the S&P 500 with 2475 providing resistance. If they break through resistance then we are off to a new range of 2475-2550. The path of least resistance is higher for now but September looms large. The animal spirits are still in charge as long as the flow of the Fed’s balance sheet is neutral to positive.

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.

Lucy’s Football

Remember Snoopy, Lucy, Charlie Brown and the gang in the Peanuts cartoon? There is the classic scene where Lucy convinces Charlie Brown to trust her and that she won’t take the football away again when he tries to kick it. Well, Lucy took the football away again this week. We have for months seen central banks moving closer to tightening policy and for risk to rise in the market. While members of the FOMC have been out in public in the last few weeks promising tighter policy, Janet Yellen , Chair of the FOMC, went in front of Congress this week and whispered sweet nothings in the ear of the market leading to one of the S&P’s best weeks this year.

In previous communications Yellen warned of the high valuations and the risks that are piling up as asset prices rise. She communicated to markets that financial conditions are getting out of balance and valuations are elevated. Markets seemed to accept the anticipated rate hikes along with a decreasing of the Fed’s balance sheet. Why did “Lucy” backtrack?  Markets are not headed lower. They have only slowed their ascent. Why is she panicking? This tells us all we need to know. ANY move lower in markets will be met with panic from the Federal Reserve under current leadership.

However, while the S&P 500 is having its best performance in months, underneath the surface, markets and internals are diverging. Movements among the large indexes are no longer in sync. We are seeing the large caps rise while mid and small caps refuse to play along. By way of Arthur Cashin’s Letter this week comes a warning from Jason Goepfert of SentimenTrader.

The correlation between the S&P 500 and the three other major indexes is the lowest in 10 years as they each go their own way. This kind of behavior preceded the market peaks in 2000 and 2007, back-to-back up days for the (NASDAQ) Composite while new 52-week lows grew and outnumbered new highs. That has only happened three other times – October 18, 2007, May 18, 2011, and October 27, 2014. The first two preceded major corrections while the latter led to a choppy market that set new highs then gave all the gains back.  7/11/2017

It seems as every day that goes by we read about another big name in the industry warning about a major sell off in the fall of this year. That make us nervous and not how you think. We are anticipating a selloff as well in what we have dubbed our “1987” trade. We have seen plenty of people we respect come around to our thesis. What makes us nervous is that when everyone agrees something else tends to happen.

This week it was JP Morgan CEO Jamie Dimon’s turn.

Central banks would like to provide certainty but “you cannot make things certain that are uncertain,”

All the main buyers of sovereign debt over the last 10 years — financial institutions, central banks, foreign exchange managers — will become net sellers now. 

“That is a very different world you have to operate in, that’s a big change in the tide,” he said. “The tide is going out.”

Ray Dalio Took his turn at the pulpit as well. We can’t help but agree with Dalio as it has been our contention since the dawn of the crisis that central bank largesse would have to end and when it did we would find that pumping money in would be a lot easier than taking it out. You can always buy in markets. You can’t always sell. That’s when risk rises and rises substantially.

For the last nine years, central banks drove interest rates to nil and pumped money into the system creating favorable carries and abundant cash. These actions pushed up asset prices… That era is ending. 

Central bankers have clearly and understandably told us that henceforth those flows from their punch bowls will be tapered rather than increase…..central bankers try to tighten at paces that are exactly right in order to keep growth and inflation neither too hot nor too cold, until they don’t get it right and we have our next downturn. Recognizing that, our responsibility now is to keep dancing but closer to the exit and with a sharp eye on the tea leaves.

Oil seems to be holding above the lows of January 2016 above $40 a barrel. Oil can’t seem to catch fire at the moment and seems range bound between $40-50 a barrel. Any time prices in the oil patch rise more supply comes on the scene. OPEC members are cheating as usual and pumping supply into the marketplace. Keep an eye on financials. Financials and oil could hold the key here. If financials rally the market will run with them. There are only about six more weeks of summer. The tapering of the Fed’s balance sheet looks to be still on schedule to start in September. We believe the market will change when the flow changes. Things are scheduled to start flowing out in September. Equities are still in the middle of the new range on the S&P 500. For now we see support at 2400 on the S&P 500 with 2475 providing resistance.   

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.

Taking Away the Punch Bowl

Happy Anniversary “Darling”!! The 10th anniversary of the GFC

This past month marked the 10th anniversary of the beginning of the Great Financial Crisis (GFC) and the dawn of the Era of Easy Money. It was also a 10 year anniversary for us. Last month marked 10 years since our move to Georgia.  Not a coincidence I assure you. Just for a second let’s take you back to the bubble before the Real Estate bubble- the Internet Bubble. We were on the floor of the NYSE during the great Internet Bubble when stocks went higher every day making college kids in their dorm room paper millionaires. That is until the bubble popped. We had the great fortune of spending our time as part of the team trading Lucent Technologies. In a world where it was usually one trader and one clerk for multiple stocks Lucent was in a league of its own. There were days that were so hectic with historical volume that it would take a team of three clerks and four traders just to handle Lucent. Such was a day in the life of the “Darling” of the Internet Bubble.

The greatest trading lesson of my life was learned through the bursting of the Internet Bubble and Lucent Technologies fall from grace. When bubbles burst things will get as bad as they were once good.  We watched as over the next several years Lucent Technologies traded from $79 all the way down to 79 cents.  Fast forward to 2006. We knew we were in a bubble in real estate in late 2006 when, with each passing week, my wife would tell me how much our house’s value had increased. We know that any object is only worth what someone else is willing to pay for it. We also knew that as the real estate bubble formed it would eventually, also, have to get as bad as it was good…and in 2006 -07 it was very good.

At that time we were following US housing starts as a way to judge the health of the housing market. In the spring of 2007 we noticed that housing starts had peaked the year prior and then they rang the bell. It is a legend on Wall Street that they never ring a bell at the top. Well, this time they did. In March of 2007 New Century Financial was the second largest subprime mortgage broker in the United States. A month later it would declare bankruptcy. We felt that we might be too late to escape from New York. We fortunately caught a buyer and sold our house in New Jersey for an exorbitant price, which according to Zillow it still has not climbed back to. As a side note, Lucent never got back to $79 either. We say this not to brag but as investment lessons learned well. Trees do not grow to the sky, Know when to cut back on your risk and Sometimes, they do ring a bell at the top.

QT

We feel like central bankers are ringing the bell. While US monetary policy is foremost in our minds bankers from Europe to Japan to England to Canada have been promoting the idea that after 10 years of crisis it is time to normalize policy. While central banks have spent the last 10 years injecting liquidity into the system to pump up asset prices they are now talking about taking liquidity out – Quantitative Tightening (QT).  If we have established that the growth in central bank balance sheets around the world has been responsible for the run up in asset prices it stands to reason that any shrinking of those balance sheets would diminish asset prices. Ironically, during our time on Wall Street the phrase QT meant that you had a questionable trade, an error that needed to be resolved and it usually cost you money. The question facing us now is the Federal Reserve making a questionable trade and will it cost you money?

The economy is growing, albeit slowing. The reason growth is slow is due to the immense amount of debt on the United States balance sheet. In their economic paper Growth in a Time of Debt, Carmen M. Reinhart and Kenneth S. Rogoff, demonstrate quite effectively that the rate of growth in an economy shrinks as the level of debt when measured in comparison to GDP rises above a certain level. The slow growth economy in the United States is now being met by a central bank that seeks to raise rates and shrink its own balance sheet. Now instead of a tailwind, our slow growth economy and markets are looking at another headwind.

As we have written in prior posts, the Federal Reserve has been acting since December with the impulse that more stimulative fiscal policy was going to come out of Washington in the post election period. The new administration trumpeted the advent of a new era with tax reform and deregulation at its core which would have been stimulative to the economy. If you recall from previous musings we felt that the Federal Reserve was going to be obligated to get out in front of Trump’s plans or end up behind the curve. The Federal Reserve has indeed sought to get ahead of the curve by applying tighter money policy. Well, Washington is at a standstill and has not provided anything in the way of stimulative fiscal policy.

Given the lack of fiscal stimulus out of Washington, is the Federal Reserve making the ultimate central banker mistake? Are they now tightening into a slowdown? The bond market seems to think so. The yield curve is flattening which indicates that bond investors do not see inflation on the horizon and see subpar growth in the economy. Yet the stock market keeps chugging along. Who is right? Generally, we always go with the bond market.  The Federal Reserve has raised rates three times in seven months while stating that they intend to raise rates again this year and three more times in 2018 while also beginning to decrease the holdings on their balance sheet starting in September of this year.

If the Fed is tightening policy then the logical question is why have rates moved from 2.62% on the US 10 year in March of this year down to the recent lows of 2.15%? Shouldn’t rates be going higher? The reason that rates are lower is that markets, quite simply, do not believe that the Fed will keep tightening and shrinking its balance sheet because the economy is not growing with enough pace and is in danger of hitting stall speed. That is shown in the flattening of the yield curve.

First the US then the World

While the United States is the most influential central bank around the world there is a coterie of central bankers who seem to be talking down asset prices in the last several weeks. They include the vice chairman of the FOMC Stanley Fischer, NY Fed chair William Dudley, John Williams from the San Francisco Federal Reserve, Mario Draghi from the European Central Bank (ECB) and Mark Carney from the Bank of England (BOE).

While we have known for some time that Equity Price Earnings ratios are in the upper quartile historically Stanley Fischer noted last week that “high asset prices may lead to future stability risks”. That is as about as close to saying “sell” as a central banker will come to actually doing so. He went on to say that it would be “foolish” to think that all risks have been eliminated and that it calls for “close monitoring” of rising risk appetites and that the corporate sector is notably leveraged. Yes, that sector is quite notably leveraged because of central bank policy. Historically low rates encouraged corporations to financially maneuver to borrow and buy back stock rather than borrow to grow their companies.  It is quite clear that central bankers are becoming more and more concerned about the levels of asset prices and their current trend ever higher.

The Federal Reserve’s John Williams spoke last week on Australian television and also made mention of the increased appetite for risk as he stated that “there seems to be a priced to perfection attitude out there” and that the stock market rally “seems to be running on fumes”. While John Williams is not a trader we respect his opinion when it comes to excessive risk taking in financial markets. He went on to say that, “as we move interest rates back to more normal; I think that that will, people will pull back on that”. Williams specifically mentioned a reach for yield when speaking of excessive risk taking.

 

“I am somewhat concerned about the complacency in the market. If you look at these measures of uncertainty, like the VIX measure, or other indicators, there seems to be a priced-to-perfection attitude out there”

                                                                                                                                           

The stock market still seems to be running very much on fumes, or is very strong in terms of that, so something that clearly is a risk to the U.S. economy, some correction there, is something that we have to be prepared for, and to respond to, if it does happen” – John Williams SF Fed

when financial conditions ease — as has been the case recently — this can provide additional impetus for the decision to continue to remove monetary policy accommodation. William Dudley NY Federal Reserve

Quite clearly we are seeing a shot across the bow from members of the Federal Reserve. 2018 is going to be a year in which central bank largesse is withdrawn to the tune of approximately $2Trillion. What we have seen so far from the United States central bank represents an opportunistic tightening from the Federal Reserve and a chance to cool down asset pricing while other countries were still pumping liquidity. 2018 represents a backing away from the decade long crisis era emergency policy measures.

Taking Away the Punch bowl

We think what we have here is a good old fashioned game of chicken. We believe that the Fed is raising rates and shrinking its balance sheet for two reasons. One is that they need bullets in the gun for the next recession. The second reason, and where we think the stock market has it wrong, is that the Fed is tightening due to financial conditions and not economic conditions. We believe that the Fed is tightening because asset valuations are becoming excessive. Basically, they are trying to pop the bubble before it gets any bigger.

We believe that the Federal Reserve’s thinking has two main problems. One is that the Fed believes in stock and not flow which means that the Fed believes a big balance sheet helps the market. We believe it is the flow that determines the direction of markets. Flow is the direction in which the Fed and the balance sheet are headed. The Fed also believes that the market will discount their talking points as they move towards QT. Perhaps most importantly, we believe that the market will change when the flow changes.

We believe that is what the bond market is seeing that the stock market does not. The Fed wants markets to cool. The stock market thinks that the Fed will have no stomach for a market downturn as the Fed will be blamed for a recession that they themselves created with tighter monetary conditions. As long as the market expects the Fed to stop tightening because of slowing economic conditions then the market will continue to rally and the Fed will continue to raise rates. Someone is going to blink first.

 There are several possible outcomes. One is that the Fed keeps hiking until something breaks. The conundrum is that if the market believes that the Fed will blink first and stop tightening then the market will continue its rise higher. If the market continues higher then the Fed will be forced to tighten more aggressively. The second possible outcome is that the market blinks and the Fed backs off. We think that the former is still a greater chance than the latter. Animal spirits are in control of the market and it takes longer to kill greed than to kill fear.  Our thesis about a 1987 type market still holds. The animal spirits are in control above 2400 on the S&P 500 and will be encouraged to force prices higher until the actual flow changes in the balance sheet of the Fed with underinvested money managers chasing the market higher along the way. Then the Fed’s hand will be forced to take away the punchbowl as the party rocks ever higher.

It is very difficult to predict market moves especially when Washington is so deeply involved. Our job is not to predict the market but unveil possible scenarios which to prepare for. We have scaled back on risk both in equities and in bond duration while trying to maximize the benefit of our cash positions. When the facts change – we will change.

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

 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

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Blackthorn is an investment adviser registered in the state of Georgia. Blackthorn is primarily engaged in providing discretionary investment advisory services for high net worth individuals.

All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. All investments involve risk including the loss of principal. This transmission is confidential and may not be redistributed without the express written consent of Blackthorn Asset Management LLC and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential offering memorandum.

Published in: on July 2, 2017 at 8:00 am  Leave a Comment  
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