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.

 

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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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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.

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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Terry@BlackthornAsset.com

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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This House is Rocking

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

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

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

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

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

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

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

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

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

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

Published in: on March 18, 2017 at 9:00 am  Leave a Comment  
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Warren Buffett’s Latest Wisdom

One thing we look forward to every year is Warren Buffett’s annual letter that comes out in February. Here is more sage long term investing advice from the Oracle of Omaha.

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.

We, at Blackthorn, as Registered Investment Advisors, have a fiduciary obligation to our clients. We are very conscious of high and unnecessary costs and how they drive down our clients returns. Patience, discipline, a well thought out investing plan and low costs. Do yourself a favor and ask your advisor to explain any and all fees that you pay. Mutual fund fees, 12b-1 fees, Brokerage fees, Investment management fees, and Wrap fees are all examples of unnecessary fees and costs.  If you are using a broker and they cannot easily and transparently list and explain your fees and costs to you then move on to someone who has a fiduciary obligation to you.

Beware the Ides of March is what you will be seeing all week in the investing media headlines. March 15th is fraught with stumbling blocks this year. A Dutch election is scheduled for this week which could move markets. More importantly, the Federal Reserve is meeting and March 15th is the day we reach a debt ceiling deadline here in the United States. The Federal Reserve will be meeting and they seem to be boxed in a corner. Rate hike odds according to Bloomberg are pushing 90%. This is the key move we have been highlighting for 2017. If the Fed does not raise rates markets may soar even higher as retail investors and animal spirits push into the market. If the Fed does raise rates it could pour some cold water on investors and slow the rally.

Retail investors are pouring into ETF’s as shown by the fact that the SPY had its largest inflow since 2014 this week and its second largest daily inflow since 2011. As per a report from CNBC company insiders are dumping stock into the marketplace at accelerated rates. For the moment caution must be heeded. Wall Street lore suggests that the third rate hike is when markets start to falter. A rate rise in March 15th would be the third rate rise of this cycle with the stated goal of two more rate hikes in 2017. History rhymes. It does not repeat. It could be different this time as we are starting from such a low level. For now, momentum is with the bulls but if retail investors are in charge things could change very quickly.

Stocks are still extremely overbought but this week they showed some slowing in their ascent. Stocks have run a long way and should stop to rest and acclimate to their new elevation. Finally, this week we saw a close in the S&P more than 1% away from its previous close. We have now not seen a move 1% lower in over 90 sessions.  Animal spirits are running high as retail investors are pouring into ETF’s like the SPY. We continue to be wary of market structure and overreliance on ETF’s. Late day marches higher in SPY are being blamed on retail buyers late to the party. Know what you own. No pushback on the idea that Germany should leave the Euro. Need to follow that one further down the rabbit hole.

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.

 

Squeezing the Lemon – Dalio and Gundlach

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

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

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

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

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

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

The13th Beer

Welcome back! So completes THE most boring summer in investing history. Well maybe not quite but pretty damn close. It is astounding that markets have been so complacent in front of the fall investing season with a litany of worries globally including our own US Presidential election less than 90 days away. I myself am much less anxious about that result since I swore off watching the nightly news shows. I highly recommend it.  What was once entertaining turned dark and depressing very quickly. All of my friends that I have un-followed for posting political fodder I apologize. I will be back after the election when things return to normal.

Speaking of returning to normal, the Federal Reserve is contemplating a rate rise at their September meeting. It seems that Fed officials may be worrying about the negative consequences of 0% interest rates. Why is this important? Savers have been punished for far too long. Pension funds and insurance companies are the biggest savers in the world and have a very important role in planning for our later years. They have been paralyzed by the 0% and negative interest rate game. The unintended consequences of the zero bound are mounting. Zombie companies stumble in the dark here in the US as they are able to float debt in the current 0% interest rate environment. Much as we criticized Japan for harboring zombies companies in the 1990’s we continue to harbor them as well.

One wonders how long they can continue to distort policy and have the system survive. The Federal Reserve continues to give the patient more monetary heroin in the thought that it will make the patient better. One of my favorite professors in college was a gentleman from the London School of Economics. He taught us the Law of Diminishing Returns. Not much economic theory works in the real world, but this law is absolute. In short, if I have one beer on a hot summer day it tastes great. The second tastes pretty good as well. The thirteenth? Not so much. Central bankers are ordering their 13th beer.

The problem is that you cannot get away from this crisis without feeling the pain of lower asset prices. The Piper must be paid. The Federal Reserve stepped in front of this crisis and has been left there alone by our fiscal policy friends in Congress. Politicians worldwide have left central banks to do the heavy lifting. Here is the problem. Monetary policy alone was never expected to rescue and stimulate the system. It was just to buy politicians time to deregulate, simplify tax codes and stimulate the economy fiscally. With no help coming from the fiscal side central banks around the world kept supplying more monetary support to the patient. The Federal Reserve wishes to get the patient off of monetary policy support. Here is the problem. The patient is not ready to stand on their own and Congress does not wish to step in and help care (fiscally) for the patient. Complicating matters is that if the patient falters Congress will blame the Federal Reserve. Don’t forget that Congress is the Federal Reserve’s boss. Since the crisis began we have all known that eventually monetary support would have to be withdrawn. Problem is, now everyone is afraid to do it. The negative unintended consequences rage on.  Central banks at some point will have to withdraw support and financial markets will shudder, shake and cry out for more medicine. Eventually they will be fine. It is time to bring the patient around. Problem is – they won’t. The Federal Reserve has too much to lose as Congress will blame them.

Until you have fiscal responsibility you are not going to have effective monetary policy.

 It (current fiscal policy) drives monetary policy to be increasingly irresponsible. – Richard Fisher former Dallas Federal Reserve President CNBC 9/8/016

http://www.cnbc.com/2016/09/08/private-equity-giant-kkr-says-the-fed-to-keep-funds-rate-below-1-percent-through-at-least-2020.html

This Friday, markets shuddered as they contemplated a rate hike in September. The data doesn’t currently support a rate hike. Could the Federal Reserve be putting subtle pressure on Congress for their support? It may not last long. If markets stumble we would expect the Fed to announce that the market has reacted so negatively that they must continue policy as is. Around and around we go.

We are a bit unnerved as the market seems to be experiencing a seemingly irrational exuberance when it comes to valuations especially when it comes to dividend paying stocks.  As long as central banks continue to expand liquidity and investors keep the faith asset prices will head higher.

Precious metals are insurance against investors losing their faith in central banks.  While investors have been pulling money from the market two buyers have been out there keeping the home fires burning. Two buyers who are not price sensitive. Corporations in the form of buybacks and central bankers. Markets could roar higher as professionals are underinvested and markets could sink lower due to a change in central bank policy. Either way, after such a quiet summer, markets are ready to move. Be prepared for anything. Welcome back.

The Federal Reserve is Becoming the Problem

 

We have contemplated writing a blog titled “How I learned to Stop Worrying and Love the Fed”. We just cannot get ourselves over that line. The Federal Reserve has created and continues to promulgate a very dangerous position as capital is mal-invested. It also continues to punish a generation of savers, fixed income retirees, insurance companies and pension funds. The zero and even, in the case of Europe and Japan, Negative interest rate environment is hampering all of these groups ability to operate.

In light of this low income environment, we are seeing larger amounts of Ponzi schemes and investment fraud out there. Salesmen are pitching hard on annuities and income oriented schemes. These schemes are being proffered as a way to get 7-8% income on your investments. There is no Golden Ticket. There is no Holy Grail. If you are being promised those levels of income off of your investments it comes with outsized risk. Please do your due diligence. Everyone from insurance companies to pension funds to individual investors are begging for income as central banks have suppressed rates. If someone promises you this run, don’t walk, in the other direction. If it sounds too good to be true, it is.

Annuities are increasingly being offered as a solution but they come with their own set of problems. You may think that you are offloading risk on the annuity provider but it may blow back at you. These insurance companies are having the same trouble you are generating income and returns. If central banks continue to suppress rates then these companies may find it hard to keep their promises or even stay in business. You will be taking the haircut along with paying their generous fees. There is no silver bullet out there folks. Just good old fashioned hard work, diligence and patience in your investing.

We have been a big proponent and holder of smart beta ETF’s. We have been overweight dividend focused ETF’s and low volatility. They have been generous providers of return so far this year as low volatility, dividend focused ETF’s and utilities have done quite well. When everyone wants in the room – we want out. We are contemplating exchanging those funds as they are now all the rage. They have over the years provided downside protection if markets falter. That may not be the case this time around. We will continue our due diligence. No decision yet. Just an early warning. Chasing yield is a very dangerous proposition. Do your homework and don’t fall for the latest fad.

According to Standard & Poor’s the S&P 500 is now down month and quarter to date while it has maintained a slight gain of 0.13% for 2016. The fourth year of US Presidents second term tends to have below average returns as the market is unsure of who will be the next leader of the free world. Once it becomes evident who the next President is the market will steady. While that outcome is decided it could be a rocky Summer but an opportunity filled Fall.

April is consistently one of the strongest months of the year and that helped returns. However, we are now entering the weakest part of the year from May until November and the election season is not going to help. I think that volatility may be even more pronounced and returns suppressed with Donald Trump in the mix. Not because of his polices or beliefs but because he is bringing a much broader audience to the game and the media is all a buzz. That talk show fodder may convince investors to keep their wallet attached to their hip until things settle down. We have faded the recent rally and continue to cull underperformers and reduce risk. It could be a volatile summer.

Not recommendations 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.

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.