Second Mouse Gets the Cheese

Howard Marks. Stan Druckenmiller. David Tepper. Legend after investing legend is coming out of the wood work to explain how overvalued the market is. Markets don’t go down because they are overvalued. That’s a condition of the market that predates a fall – it doesn’t cause it. The legends’ comments tell us one thing. The intervention of the Federal Reserve caused them to miss the lows and they want in at cheaper prices. A selloff here would be welcomed by many.

Hedge funds and day traders are all in. The options expiration in June is always one of the largest. That had the effect of locking the market in a range. It now has the potential to get unlocked. More volatility is on the way especially in these very thin summer markets. Corporate buybacks are also going into a blackout period. That could help the bears and investing legends who are rooting for the return of volatility and lower prices.

Short one today – Father’s Day and all. It’s time to go celebrate with Diane and the kids. The second wave of this virus is on the way. I am not an epidemiologist or amateur magician. It just has that feel. People are starting to ignore all the guidelines and precautions. It is coming back folks. As our mentor Arthur Cashin is fond of saying – It’s the second mouse that gets the cheese.

Happy Father’s Day to all the dads out there especially my own. Stay safe.

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

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

 

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

 

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.

Bump in the (Silk) Road?

With each passing day, week and month we are more in awe of this market. It just keeps plugging along higher and higher. There is no predicting when the momentum will shift so we continue to be invested but just a little less so. The winning strategy is to recalibrate our investing, downshifting in our risk while seeking better risk adjusted returns. It is not our job to prognosticate but to keep an eye on what could upset the apple cart and how to profit from it. Our latest worry is China. China has just completed its most recent 5 Year Congress. Every 5 years the leaders in China get together to elect leadership and formulate the next 5 year plan. Xi Jinping continues to consolidate his power and his grip on one of the great economic engines on the planet. Leading into the congress the leadership there chose stability over change. Now that the congress is over Xi can get back to work. We are looking at China to see if, now that leadership has another 5 years in charge, change is about to come to China. Will China now try to reel in shadow lending in the country and its rampant real estate market? Will they allow a more rapid depreciation in the Yuan? If change comes to China it will reach our shores soon enough as the economic ripples will be felt worldwide.

From Cashin’s Comments this week comes some interesting facts cited by the sharp eyed Bob Pisani from CNBC.

Technology is so strong this month that it accounts for 75% of the gain in the S&P 500, according to Standard & Poors. Without Tech, the S&P would only be up roughly 0.5%. It’s worse than that: five stocks are most of the gain. Big tech this month Facebook up 15.5% Amazon up 12.5% Apple up 8.2% Google up 6.1% Microsoft up 6.0%…Those five stocks accounted for 52% of the gain in the entire S&P 500. What happens if we look at the S&P 500 and equal weight all of the stocks? A very different picture. There’s an ETF for that: the Guggenheim S&P 500 Equal Weight ETF (RSP) is up 1.1 percent for the month. That is exactly half the gain of the regular S&P 500. 

Investor sentiment is always hard to gauge but we keep an eye on it to try and delve where the animal spirits reside. Market pundits have described this rally from 2009 as the most hated rally ever. Most hated maybe because investors have been behind the curve the whole time chasing it ever higher. Also from the NYSE’s resident sage, Arthur Cashin, comes this opinion on market sentiment from Peter Boockvar at the Lindsay Group. Maybe investors have now caught the tiger by the tail. 

This boat is now standing room only. Investors Intelligence said Bulls rose 1.2 pts to 63.5, that is the highest in about 30 years. It peaked at 65 in 1987. Bears fell to 14.4 from 15.1 and that is the lowest since May 2015. The spread between the two of 49.1, is just below the 1987 peak of 50.5. I’ve said this before, when sentiment gets this stretched, markets tend to consolidate its gains.  Given those figures, it’s tough to claim that this is the “most hated rally in history”.

The market has finished higher ten months in a row!! In a era of monetary extremes this is one for the ages. We have never had a year that the market closed higher for the first ten months of the year. Never. By way of Deutsche Bank’s Jim Reid, we see that the record is 12 months in a row set in 1949-1950 and 1935-1936. We grow concerned that the rally is growing even more stretched and more narrow in its rise. The techs are in charge as the Big Five accounted for half of the gains last month. A rally that grows more and more narrow is not a healthy market. S&P 500 shows signs of slowing its ascent. The market could use a consolidation period. It makes for a much stronger foundation. The bulls are still in control but with the President out of the country we tend to get a little nervous. We still see 2600 as logical resistance for now. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less in.

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.

Yellen – More Punch Anyone?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Coming Retirement Crisis

It is hard to believe but over twenty years ago while on the floor of the NYSE I asked Arthur Cashin whose work should I be reading. He recommended a, then little known, writer of financial information by the name of John Mauldin. Little would I suspect that over two decades later I would still be enjoying John’s insights. He has access to some highly placed sources and savvy investors. John’s email list for his letter has grown to over 1 million subscribers. It is free so sign up. Here is the link to John Mauldin’s Letter Thoughts from the Frontline.

In this week’s letter John touches on the issue closest to my client’s hearts. When can I retire? We have an expectation in the United States of being able to retire at the age 65 and possibly even earlier. We even base our career success on how many years before 65 we are able to retire. The concept of retirement is a relatively new concept. The advent of Social Security under the FDR administration in 1935 was developed as a safety net for our elderly. The age of 65 was considered because the poverty rate of the elderly in 1935 was over 50%. The life expectancy of a male in the US in 1935 was 59.9 years old.

In 2016 that number has risen to over 76 years of age.

I’ve said this before, but it’s worth repeating: “retirement” is a new concept. For most of human history, people worked as long as they were physically able and died soon thereafter.

Defined-benefit pensions are rare in the private sector and unstable for government retirees. Individual investors tend to lose their money in market crashes and are often lucky just to break even. Even government plans like Social Security are in increasingly questionable shape. – John Mauldin

The answer is pretty simple but it is the one no one really wants to hear. Don’t retire! The reality is that according to the Social Security Administration a man who turns 65 today can expect to live on average to 84.4 years old. A woman turning 65 today can expect to live on average until the age of 86.7. That is just the average. In this day and age of better healthcare and advances in biotechnology one must plan to live until 100 years of age. That is 30 years of retirement if one chooses to work until 70!! That’s a lot of golf.

Ironically, the research pretty much universally shows that many people working past normal retirement age do so for their own personal reasons rather than out of necessity. The data in the United Kingdom, which is not much different from the picture in the rest of the developed world, suggests that almost half the people working past traditional retirement age are doing so simply because they don’t want to stop working. And many people who say they are “retired” still work long hours just to “keep busy.”

Alicia H. Munnell, a Boston College economist who was previously Assistant Treasury Secretary in the Clinton administration spoke recently about the coming retirement crisis in her speech titled, “Falling Short: The Coming Retirement Crisis and What to Do About It.”

Her main thesis is that you should prepare to work longer and yet still enjoy retirement as long as or longer than your parents and grandparents did.

Assuming you started work at age 20, rising life expectancy means that if you retire at age 70 in 2020, you will have the same work/retirement ratio as someone who retired at age 65 in 1940. My generation is enjoying better health in our later years than our parents did. We work longer simply because we can and because we enjoy it.

By Munnell’s calculations, simply working until age 70 will do the trick for most people. The extra working years will give your savings more time to accumulate. Your Social Security benefits will also be higher once you do retire.

JPMorgan’s Marko Kolanovic has been spot on for the last several months as he has picked the bottoms and tops of the market moves since last October. He is out with a different warning this week. He is looking at the market from a more macro perspective and I happen to agree with his thoughts. The next move from governments and central banks may be fiscal policy. It is the only weapon left and it may have serious implications on your investing.

Central banks, Inflation, and Debt Endgame

With the Fed and BoJ meetings behind us, markets are increasingly accepting that central banks are nearly out of options. Central banks can hardly raise interest rates, and there is a growing realization that negative interest rates simply make no sense. Unconventional approaches of buying corporate bonds (ECB) and stocks (Japan) so far have not produced significant results, and run the risk of tainting these assets for private investors. The next attempt to boost the economy or prevent a potential market crisis will likely need to be accomplished by fiscal measures.

Increased government spending, financed by central banks could indeed create inflation, but will further elevate the problem of debt viability. 

We always keep an eye on seasonal factors. The old saw of “Sell in May and go away” harkens back to days when we were an agrarian society. Money was put into the fields in the spring and when harvest came in the fall money was put back into banks and markets. To this day we are creatures of habit. Money managers are likely to take risk off of the table and less likely to put money to work in new ideas because summer is coming. Liz Ann Sonders from Charles Schwab had a recent note on the “Sell in May” theory.

We are in that “season” when you will hear a lot about whether it’s appropriate this year to “sell in May and go away,” which is one of the most time-honored market adages, and for good reason. Since 1950, nearly all of the S&P 500’s gains have occurred between October and April. The mean return since 1950 for the S&P 500 during May through October was 1.3%; while for November through April it was 7.1%.

Markets are also more susceptible to geopolitical developments or changes in monetary policy due to skeleton crews on trading desks in the US and Europe. Moves can be outsized. We will continue to look for opportunities given any developments. In our last blog post we asked you to keep an eye on gold. We feel that investors could find solace here as the games of currency wars and negative interest rates heat up. That has been a good place to be. Inflation is also increasingly on our minds. Not because it is showing up in the statistics but because it will be the only way out for indebted nations around the world. Their only exit from their extreme debt positions will be to inflate away their debt.

Not recommendation just information. Investing is not a game of perfect.  It is a game of probabilities.

 

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.

Ride the Wave

So much has happened and so much to talk about. We could talk about the seemingly globally coordinated easing from central banks around the globe. Central banks easing policy in the last two weeks have included Norway, Sweden, the Bank Of Japan (BOJ), the European Central Bank (ECB), the Chinese central bank and of course our own recent dovish statement from the US Federal Reserve,. We could talk about how that has led to a weaker US Dollar which in turn has helped oil, precious metal and emerging markets stage a turnaround in fortunes. Or perhaps we should discuss how Central bank maneuvers have helped US markets regain all of the ground they had lost so far in 2016.

We could talk about all this but here is what we think would be most useful right now. The key to making money in these markets lies in Investor Psychology. How we understand it and our own emotions when it comes to investing our money is the key to success.  Here are two charts that can help you be more successful in understanding how emotions play a role in your investing process.  Courtesy of CNBC, the first chart shows two 12% rallies in the last 7 months. The second is a chart of investor psychology. After our second 12% rally in 7 months you should ask yourself, Where are you on this chart? Are you relieved? Optimistic? Thrilled? Sell risk when prices are rising and buy risk when prices are falling. Understanding and keeping your emotions in check is the key to making money in markets like these. Ride the wave.

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

 

 

 

If the Dow Jones holds its gains for the next two weeks we will have seen the biggest quarterly comeback in stock markets since 1933. We don’t have to remind you that the 1933 rally took place smack in the middle of the Great Depression. Risks are rising after our second 12% rally in months. It is going to be hard to move higher from here but don’t bet against continued central bank largess. The stock market is up 12% in 26 trading days. Not bad. But it does remind us of a blog post from back in October of 2015.

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

As a reminder the S&P 500 closed October of 2015 at 2080. It would be 10% lower by January of 2016.

Central bank policy in Europe and the US is having the same effect. Earnings estimates are heading lower while stocks ride higher. Not a great recipe for success. Risk is rising.

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

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

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

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

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

What’s Next in 2016?

Summary 1/11/2016

Arthur Cashin – Volatility is Back!

Echoes of 1937

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

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

I will gladly pay you Tuesday for a hamburger today.

– J . Wellington Wimpy

Volatility

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

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

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

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

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

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

1937

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

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

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

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

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

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

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

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

The similarities are staggering.

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

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

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

Former Dallas Fed Pres Fisher 1/5/2016 CNBC

 What Next?

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

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

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

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

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

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

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

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

Santa’s Sleigh Bells

The media and blogosphere have lit up with their prognostications as to whether Santa Claus will make his appearance on Wall Street this year. One point of order is to note that the traditional Santa Claus Rally is not the entire month of December. It is only the last 5 trading days of the year and the first two of the New Year. But the gain is only on the order of 1.5%. The market was up 2% yesterday! What we really need to be on the watch for is if Santa does not come. The old saying goes, “If Santa Claus Should Fail To Call, Bears May come To Broad and Wall”. If Santa does not come as ordered the market may be telling you that it is headed for trouble.

But even if it does get into trouble won’t the Fed just bail us out of it? In an interview yesterday Mario Draghi, Head of the ECB, stated as much. When asked by Mervyn King, former Governor of the Bank of England, whether his speech on Friday in NY was meant to counteract Thursday’s market disappointment he responded “of course”.

Federal Reserve officials may follow Draghi’s lead in 2016 as they begin to try and get off of zero interest rates. According to our good friend Arthur Cashin, the last time that the Fed raised interest rates with the ISM below a reading of 50 was in 1981. (A reading of below 50 on that report indicates that we have an economy that is contracting rather than expanding.) In 1981 inflation was running at over 10%. The market fell 23% over the next year.

Here is what we are watching in relation to the Federal Reserve hiking interest rates. The first hike generally does not hurt stock prices. It is the second and the third. In late 1936 we were still experiencing the effects of the Great Depression. Inflation began to tick higher and the stock market was also headed higher. Officials began to think that raising rates was appropriate. Unfortunately, they were tightening monetary policy while other countries we still busy trying to devalue their currencies. Demand for dollars increased sharply.  Sound familiar? Stocks bottomed out in 1938 down almost 50% from their highs. Not saying it is going to happen again but history does have a tendency to rhyme.

Bill Gross, known as the Bond King, had this to say this week on risk and asset prices.

Timing is the key because as gamblers know there isn’t an endless stream of Martingale chips – even for central bankers acting in unison. One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down. But when? When does Martingale meet its inevitable fate? I really don’t know; I’m just certain it will. Doesn’t help you much, does it. Except to argue that much like time is relative to the speed of light, the faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets. I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money. Even Martingale casinos eventually fail. They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close.

We have seen an upswing in volatility here in the 4^th Quarter of 2015. We believe that portends a higher range of volatility across asset classes in 2016. While we believe it is going to be a positive year it will not be without its bumps and bruises. Tactical allocation decisions may be the key to increasing your gains or even perhaps having gains at all.

While we are cognizant of low returns in this environment we still think it prudent to have some cash on the sidelines. A policy error could have severe consequences for asset prices. The United States may have worked their way out of this crisis and repaired its balance sheet but what about the rest of the world? A policy act by the Federal Reserve could send the tide out and we may find that some countries have been swimming naked. In the event of large market swings in 2016 the FOMC may be forced to bring more easy money in the form of QE. We think that, for investors, 2016 is going to be anything but easy money.

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

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

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

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

Fickle Stock Markets and Daughter’s Driving

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

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

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

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

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

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

When there is no one left to sell…

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

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

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

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

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

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

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

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

Cash

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

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

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

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

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

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

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

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