Fed Up

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

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

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

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

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

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

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

Squeezing the Lemon – Dalio and Gundlach

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

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

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

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

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

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

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 13^th 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.

Roller Coaster Markets

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

Well, that was some beginning to 2016! We knew that volatility was coming our way but we did not foresee what happened in Q1. The Dow Jones managed to complete a round trip ticket as we fell 13% and subsequently rose back up 13% in one quarter. That is the biggest intra quarter comeback since the middle of the Great Depression in 1933. Our portfolio strategy coming into 2016 was to tactically manage our asset allocations given that we expected higher volatility and lower returns. Although we didn’t see a round trip in the offing for Q1 of 2016 our strategy worked out quite well. We believe that the rest of 2016 has much the same in store as the market reacts to every nuance emanating from the Eccles Building in Washington DC which is the home of the Federal Reserve Bank of the United States.

We believe that risks are rising after our second 12% rally in months. We have elevated valuations and falling earnings estimates for US companies. It is going to be difficult for the stock market to move higher from here but we cannot bet against continued central bank largesse. The stock market, having rallied 13% off of its recent lows in early February reminds us of a blog post from back in October of 2015. This is what we had to say back in October.

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 volatility continued then as well. The S&P 500 closed October of 2015 at 2080. It would be 10% lower by January of 2016.

The key to making money in your portfolio lies in Investor Psychology. Understanding investor psychology and our own personal relationship with money is the key to successful investing.  Having just ridden the roller coaster of emotions that was Q1 we are in a good position to replay how the highs and lows of the market made us feel and how we reacted to it. The two following charts can help you be more successful in understanding how emotions play a role in your investing process.  The first 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 we should revisit how that roller coaster made us feel. Were you despondent at the lows? Did it make you want to sell and get out or buy more? Are you now relieved? Optimistic? Are you aching to buy more as prices rise?

 

 

In order to be on the right side of the market it is important to sell risk when prices are rising and buy risk when prices are falling. Or in emotional terms, when prices are falling and you are scared ask yourself “What should I be buying”? When prices are rising, ask, what are we selling? Understanding and keeping your emotions in check is the key to making money in markets like these. Ride the roller coaster.

 Valuations

For long time readers and clients you know that one of our favorite metrics of stock market valuation is the US Stock Market Capitalization to GDP. It also happens to be Warren Buffett’s favorite metric in case you wonder why we follow it as well. As you can see from the following chart courtesy of Ned Davis Research the last time that the Stock Market Capitalization as a percentage of GDP was in an undervalued position was in July of 1982.

What changed since the early ’80’s? Central banks gained enormous influence over markets when President Richard Nixon took the United States off of the Gold Standard. This allowed central banks to help manage booms and busts in the economy without being hamstrung by the amount of gold in Fort Knox. Theoretically, they now had an unlimited supply of gold with printed fiat money taking the place of gold. This was the dawn of the Golden Age of Central Banking. The Prime Interest rate from the Federal Reserve reached its high of 21.5% in June of 1982. We have had a steady trend of lower interest rates for the last 30+ years.

Since 1995 (with the exception of February 2009) we have been in the overvalued area of the chart. This chart is evidence of the inexorable influence of central banks on asset prices. Some questions remain. Are we in a permanent state of overvaluation due to the influence of central bankers? If that state of overvaluation is not permanent at what point does central bank influence wane and valuations retreat to historical levels. Also, if central bankers remain in control of markets how low will central bankers allow markets to descend? Given our current inflated valuations we know that based on history we can expect lower returns over the next 10 year time frame.

Another natural question is posed if we feel that returns are to be muted or that prices should retreat. Why not sell out of all our assets and wait things out in cash? I think that the chart also answers that question. We have been in a perpetual state of overvaluation since 1995 – over twenty years!  In order to meet our investing goals we cannot afford to sit out markets until they become more rationally priced. There is also the distinct possibility that markets become even more overpriced. If inflation were to take hold here in the United States investors would want tangible assets that rise in value with inflation. Equity prices could become wildly overpriced.  John Maynard Keynes, the legendary economist once said, “markets can stay irrational longer than one can remain insolvent” betting against them.

We know that it has been a goal of central banks since the dawn of the crisis in 2008 to raise asset prices and therefore raise confidence in the economy but they are now distorting price discovery with monetary policy. This extreme action taken by central banks takes away some of our normal techniques for evaluating markets as markets are warped by policy.

Less Gas in the Tank

Unfortunately, the Federal Reserve has recently discovered with its latest interest rate hike that they are now the WORLD’s central bank and its moves have outsized effects on the rest of the world.  Central banks can pull future returns forward and stall for time so that legislators can enact fiscal policy with which to mend an ailing economy. However, due to reluctance or ineptitude legislators have done nothing and left central banks, and in particular, the US Federal Reserve as the only game in town. If the Federal Reserve raises rates it then weakens other currencies and encourages capital flight. Capital goes where it is treated best. Higher rates of interest in the US and a stronger US Dollar force money to quickly flood out of emerging nations and into the United States. Central banks are stalling for time and currency wars are de rigueur. We have entered a “Twilight Zone” of monetary policy with negative interest rates in Europe and Japan. Central bank officials are also faced with the fact that monetary policy is not immune to the effects of the Law of Diminishing Returns as we enter Year 8 of a bull market in stocks.

Most likely, as risk premiums increase, central banks will increasingly ease via more negative interest rates and more QE, and these moves will have a beneficial effect. However, I also believe that QE will be less and less effective because there is less “gas in the tank.” – Ray Dalio Bridgewater Associates  2/18/16

What’s Next?

And while QE will push asset prices somewhat higher, investors/savers will still want to save, lenders will still be cautious lenders, and cautious borrowers will remain cautious, so we will still have “pushing on a string.” As a result, Monetary Policy 3 will have to be directed at spenders more than at investors/savers. In other words, it will provide money to spenders and incentives for them to spend it.  Ray Dalio Bridgewater Associates

This latest rally saw investors chasing safe haven and dividend paying stocks like consumer staples and utilities. Investors are moving ahead but with caution. Other safe haven assets performed well in Q1 such as US Treasuries, Municipal bonds and Gold. We are also seeing investors maintain cash positions to levels not seen in years. We think that those are good signs. The fact that investors have sought and are seeking shelter will provide some cushion to any market tumble. Investors are preparing for another 2008 style crash. That, in essence, is why 2016 is NOT 2008.

Clients have been asking what metrics we are looking at as far as taking more equity risk. The 200 Day Moving Average (DMA) is the Maginot Line when it comes to seeing markets as bull markets or bear markets. Obviously, we would take more equity risk if we felt that we are in a bull market. Currently with the S&P 500 in a battle to take flight above its 200 DMA we are inclined to believe that we are still in a bear market and continue to hedge risk. If the bulls can get above and stay above the 200 DMA in the S&P 500 we would be more inclined to changing our mindset.

Oil’s bounce is alleviating pressure on borrowers and drillers but prices need to get back above $50 a barrel to really stop the pain. Currently, as we write West Texas Crude is below $40 a barrel. The selling of oil and oil related debt may be easing for now but the pain may only be delayed. High yield debt has seen money pour into that sector in the last month. Investors may be catching a falling knife there with more pain to come if oil cannot continue its recent rally.

We will continue to tactically change our asset allocation as the S&P 500 stays range bound between 1800-2100 and volatility continues its resurgence in 2016. We continue to hold bonds as it has been the most unloved of asset classes for the last several years as short sellers have been betting on rising interest rates and falling bond prices. In Q1 of 2016 bond returns have been in excess of 2% which is a very nice quarter for bonds. We see bonds as having value while the US 10 year yield is still north of 1.8% as we write while Japanese 10 year rates are less than zero. We feel that there is still adequate return to entice capital from around the world into US government bonds at 180 basis point spreads.

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.

We still 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 is also an important part of asset allocation because although it returns zero when risk premiums rise its value will be seen in its inherent call optionality and the opportunity set that it provides given lower asset prices.

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

 

 

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.

30 Second Timeout

 

Investors are breathing a sigh of relief as the S&P 500 has bounced 5.9% off the lows of 2016. It was almost as if a starter’s gun was fired the morning after New Year’s 2016 and investors have been racing ever since. Now, investors have been granted a 30 second timeout to catch their collective breath. It might be time to get back on the court.

The S&P 500 closed Friday at the 1917 level. The bears will look to stop the bulls advance at first 1940 and then 2000. The S&P has returned to the 1812 level several times now and that is the space that bulls must defend. Technical analysts are calling attention to that level as any breech of 1812 could propel markets lower. As the price of oil continues to stay below $40 more and more pressure will be brought to bear on oil companies to pay back debt and there will be pressure as well on the banks that hold that debt. Round and round she goes as negative pressure begets increased negative pressure and lower prices beget lower prices. Those forced to sell will be selling into a spiraling lower price and be forced to sell more assets to raise capital. For now, the risks still seem to be leaning to the downside. Credit risk is rising.

We are seeing investors fleeing stocks and moving into safe haven assets such as US Treasuries, Utilities, Municipal bonds and Gold. Jeffrey Gundlach, the current Bond King, has been prescient in his market call of late and has stated that Muni bonds may in fact be overbought at this time. It shows the level of fear that investors have gotten themselves to. We are also seeing investors raise cash positions to levels not seen in years. We think that those are good signs. The fact that investors have sought and are seeking shelter will provide some cushion to any market tumble. Markets are preparing for another 2008 style crash. That, in essence, is why 2016 is NOT 2008.

We have been underweight equity allocations and heavily overweight cash.  We have also been using volatility as a hedge this year and that has worked out quite nicely. We sold our hedges as stocks bounced off of their more recent lows and are currently un-hedged (other than cash positions) but that could change at any time. Hedging is like insurance. It costs money but you will appreciate having it if the house burns to the ground. It sounds easy and without risk but it is not and the use of hedges must be done judiciously. Tactically applying portfolio hedges at the appropriate times will allow us to outperform in a down market.

Remember, markets go down far faster than they go up. We are not making predictions here. Investing is not a game of perfect.  It is a game of probabilities. Keep an eye on gold. Foreign investors could find solace here as the games of currency wars and negative interest rates heat up.

 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.

Where to Place Your Bets

 

Speaking to clients this week all the talk was about the Super Bowl, the election and how far markets have to fall. First of all, let’s just get the Super Bowl talk out of the way. We are of the sentimental type and are wishing that as this is Peyton’s Manning’s’ last rodeo we hope that he gets to go out on top. Having said that Barack Obama is in his last rodeo as Commander in Chief and statistically speaking, last rodeos by second term President have never been very good for markets.

Markets hate uncertainty. By not knowing who will occupy the White House in January market participants do not know where to place their bets. According to Sam Stovall over at S&P IQ the fourth year of a second term President is up only 44% of the time versus the average year of being positive 66% of the time. The returns, as you might expect, are also subpar. The average fourth year of a second term US President is down 1.2% versus the average stock market return of 7% since 1900. If the market players do not know who is going to be President they do not know where to place their bets. For example, if a Democrat were to occupy the White House in January market players may bet on wind and solar. If, on the other hand, a Republican is in the White House beaten down coal companies might be a good bet. So you see it is not Hilary vs. Trump that has the market in a tizzy. It is the uncertainty. The market is agnostic on the race for the White House. It just wants to know which way to bet.

We have said in prior posts that it is really all about the Federal Reserve policy unwind that is moving markets but it does have other co-conspirators. The other underpinnings of doubt are the race for the White House, China and the price of oil. As those underpinnings become resolved the market can regain its footing because in becoming resolved they may precipitate a sharp fall in asset prices which could change Federal Reserve polices.

How far could prices fall? Again from Sam Stovall, we see some excellent statistical information in the following graph.  A bear market is conferred when stocks fall 20% from their peak. The peak of our current market was seen on May 21^st of 2015 at the price level of 2130 on the S&P 500. The average bear market since the end of WW II falls 32.7% while taking 9 months to fall 20% and 14 months to eventually hit its bottom.

 

 

Looking at Mr. Stovall’s chart what stand out to us is the 1968 – 1982 period. Much as the 1966-1982 period we believe that we are in a secular bear market. Much like the 1966-82 secular bear we have had two Mega Meltdowns. If history does not repeat but rhyme we could enter our third cyclical bear market of the 2000-2018 secular bear market and we would expect it to mimic the 1980-1982 bear market. We believe that we may be entering what S&P IQ would term a Garden Variety bear market. Those averages would call for a 26.4% down move from the peak that would last 14 months in duration. The 1980 bear market lasted 20 months and was lower by 27.1% from its peak. Numbers such as those would put our markets at 1555 on the S&P 500 in July of 2016.

We are not finding many bulls in the market right now. That alone tells us that investors are prepared after two Mega Meltdowns in the last 16 years. If we are to have a bear market we think it far likelier that we will have one of the Garden Variety and this summer investors may have a better idea of where to place their bets.

As investors we create scenarios and try to invest appropriately. Using this information we have had lower than normal equity allocations and higher than average cash positions. We are also currently hedging our equity allocations for our more aggressive clients. That should allow us to outperform in a down market. Remember, markets go down far faster than they go up. We are not making predictions here. 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 End of the World

The end of the world is a terribly bad bet but yet television pundits were out in force last week proclaiming the beginning of a bear market and perhaps the end of the world as we know it. The definition of a bear market is a market that is down 20% from its highs. At the S&P 500’s lows last week the market was already down 15%. It doesn’t take a rocket scientist to predict that the market has a 50/50 chance of going down another 5%.

The reason that the pundits are out and about screaming like Chicken Little is that they were not prepared for a move lower in asset prices. We, on the other hand, had lowered our equity allocations and raised our cash position. That way we were prepared to outperform given a sharp move lower while having excess cash to deploy given better valuations and cheaper assets. Being an asset manager is a lot like being in charge of buying the groceries. If one is in charge of buying the groceries you haven’t done your job appropriately if when going to the grocery store and finding New York Strip marked down 15% you don’t have any cash in your pocket.

We have been underweight equities and overweight cash for some time now seeing an overvaluation in asset prices. This overvaluation in asset prices coupled with the unintended negative consequences of the Federal Reserve’s zero interest rate policy led us to surmise that a re-pricing of assets was in order. While underweight equities at that time we did not feel as though we would miss any truly outstanding returns. Given stretched equity valuations it seemed far better for us to have some insurance in case markets headed lower. Markets go down far faster than they go up and any underperformance is quickly made up with an outsized cash position. Suffice to say 2016 has been a boon to relative performance if one was prepared for this correction in the markets.

Howard Marks latest missive came across my desk this week and as my long time readers know I read everything from Mr. Marks that I can find. He is one of the great investing minds of our time and is kind enough to share his thoughts on investing. Mr. Marks has warned for some time that valuations were a bit rich by telling us to “move forward, but with caution”. It is now that he sees better values. While not saying that now is THE time to buy he does mention that now may be A time to buy.

As I mentioned above, since the middle of 2011 – by which time the quest for return had resulted in rather full prices for debt, over-generous capital markets and pro-risk investor behavior – Oaktree’s mantra has been “move forward, but with caution.”  We’ve felt it was right to invest in our markets, but also that our investments had to reflect a healthy dose of prudence.

Now, as discussed above, investors’ optimism has deflated a bit, some negativity has come into the equation, and prices have moved lower.  Depending importantly on which market we’re talking about and how it has fared in recent months, we consider it appropriate to move forward with a little less caution. – Howard Marks

 

We have fielded a larger number of calls this week from concerned clients and we take our role as counselor seriously.  Being in tune with one’s emotions is probably the most important criteria for investing success. As a former specialist on the NYSE it was our job to be a provider of contra liquidity. That is to say it was our job to be buying when others were selling and selling when others were buying. It was a great training ground to understand one’s own emotions and of the potential madness in crowds. It trained me to have a contrarian viewpoint. When confronted with excessive buying or selling by market participants it naturally became an instinct to question the extreme nature of the emotions driving that buying or selling.  It is not to say that the crowd was always wrong or that we do not feel the emotions of fear and greed. It is that we are keenly aware in that moment to be objective in our approach and to recognize when there is fear or panic in the sellers mind and act appropriately. By being aware of one’s emotions one can more easily use others fear or greed to profit.

That’s one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not so hot.”  But in the world of investing, perception often swings from “flawless” to “hopeless.”  The pendulum careens from one extreme to the other, spending almost no time at “the happy medium” and rather little in the range of reasonableness.  First there’s denial, and then there’s capitulation. Howard Marks – Oaktree

The same concern seemed to be repeated one every client call this week. “Is this 2008 all over again?” Quite frankly, I don’t believe so. I think that this situation is different. I think that most investors are suffering from recency bias. Recency bias is the tendency to think that trends and patterns that have happened in the recent past will occur again. Investors burned by the 50% downturn in the Internet Bubble of 2000 and the 50% downturn in the Housing Bubble of 2008 are afraid that we are at that same precipice again. I do not have a crystal ball but I do not see the same excesses in current markets as I saw in 2000 and 2008 but I do see investors preparing for a coming storm. If investors are prepared then the storm effects will not be as bad as when they were not prepared in 2000 and 2008. Furthermore, it is our perception that there are overvaluations that need to be corrected but not bubble type excesses. Even in the oil sector there were not bubble like valuations but just simply a misallocation of resources due to Federal Reserve zero interest rate policy. The negative implications of which have obviously come to pass. It also seems that while the bursting of the Housing Bubble in 2008 did bring us to the brink of a global meltdown that was mostly due to the weak balance sheets of US banks. That is no longer the issue that it was in 2008 as the Federal Reserve has made sure that bank balance sheets, at least here in the US, are much less vulnerable than they were in 2008.

So let’s all back away from the ledge. It is not the end of the world as we know it. If we can understand our fear and use it to our advantage we will be better off for it in the long run. We are positioned appropriately and looking for that New York Strip to go on sale.  We will continue to maintain albeit somewhat higher levels of cash as equity valuations continue to become more reasonable and put those dry powder funds to work. We think it will be prudent to avoid exposure to momentum stocks and continue to rotate into more reasonably valued shares.

 

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.