Foot on The Gas

Will the Fed ever normalize or even just stop adding liquidity? If, in 2007, you had a discussion with anyone in our industry and predicted where we would be with monetary policy in 2019 they would have laughed you out of the room. Policy at this juncture reminds us of the Weimar Republic Germany during the 1921-23 period. In preparation for WW I, the German government borrowed for the costs of the war. They would easily win the war and pay for it with the reparations they would demand from their defeated enemies – as was the custom of the day. Turns out taking the Kaiser and giving the points was a bad idea. Now, having lost the War to End All Wars the Germans were forced to pay up – not collect. What could they do? They decided to print money, buy foreign currencies with it and pay back their debts. Only thing is – that had a double – whammy effect on the German currency. The German currency went lower because they were printing more of it and the foreign currency they bought went up in price driving the German currency even lower. Inflation got so out of control that the cost of bread would double by noon. The problem was that the only thing worse than continuing the policy was stopping it.

The Federal Reserve is in the same position as the German government. The only thing worse than continuing QE is stopping and reversing QE.  There is a clear result to their stopping and/or reversing QE. Markets will go down. If markets go down the corporate debt market will seize up. If the corporate debt markets seize there are no more buybacks and the support pillars of the stock market are removed. Remove those and you lose consumer confidence. Lose confidence and the economy spirals. We had a bump in the road in the money markets earlier this year and, fearing disruption in the markets, the Fed resumed QE at a faster pace than QE 1, 2 or 3 all with the S&P 500 at all time highs. Does anyone really believe they will be able to stop QE let alone reverse QE? Stop QE and you are faced with an economic recession, if not, depression. Don’t stop QE and you are left with a gravity defying stock market that has lost its logical underpinnings. We are beginning to believe that we have to have a monstrous blow off top in equities in order to convince government regulators to take their foot off of the gas pedal.

There is a palpable feeling of FOMO in markets as we approach year end. We have entered the seasonally favorable period for stock market returns and investors are chasing asset prices higher. It doesn’t help that corporate buybacks are hitting all time levels while the amount of stock shrinks propelling stocks ever higher. Equities are bit over bought here and due for a rest but FOMO is strong as professional investors lag further behind benchmarks.

Bonds and stocks diverged a bit in the past two weeks in a risk off pattern. We feel that corporate debt and high yield in particular hold the key. A massive amount of debt is piled in the BBB region. Should that debt fall into junk territory corporate buybacks could suffer and they are the linchpin of markets. High yield seems to be struggling here as distressed investors look at the junk laden energy sector as their next playground.

“if the economy encounters a downturn, we could see a good deal of corporate distress. If corporations are in distress, they fire workers and cut back on investment spending. And I think that’s something that could make the next recession a deeper recession”. – Janet Yellen former FOMC Chair

Small caps and transports refuse to budge out of their recent ranges. It is getting hard to argue though as the S&P break higher is dragging financials, tech and health care with it. The Fed is dragging us all back into markets with their adding to liquidity.

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.

WW III

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

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

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

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

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

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

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

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

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

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

The Trump Rally Meets The Swamp

The Trump Rally while rooted in ideology and investment theory is not necessarily rooted in reality. While tax reforms, reduced regulation and fiscal stimulus could make for a powerful combination stoking the economy and inflation it is not certain this combination will actually happen and if it does happen it will not happen for some time. Expectations are running a bit too high and this is still Washington DC after all. The roots of the Trump Rally are bound to get stuck in the mud of the Swamp.

Interest rates and the US dollar are rising which can be a dangerous combination. The market can rally with rising interest rates and we believe that it is healthy for interest rates to rise from here and that low interest rates were actually inhibiting growth in the economy. Some semblance of higher interest rates are good for the economy. But for the stock market the current high level of valuations were predicated on TINA (There Is No Alternative). At some point, bonds, real estate or other asset classes become an alternative. The high levels of asset valuations were predicated on low interest rates as all investments are evaluated versus the risk free rate of the 10 year Treasury. A rising ten year means that models may have priced assets too richly.

As you know we follow certain financial leaders and Jeff Gundlach at DoubleLine is one we find most open with his thoughts. Gundlach is on record saying that the 10 year could go to 6% in the next 4 or 5 years. We are of the same thought although not as drastic. In the near term we believe that yields have gone too far too fast along with equities in the post Trump win world. Gundlach spoke to Reuters this week and caused markets to pause as he said much the same. Gundlach feels that the bond selloff has seen its low for now and stocks will take a breather before Inauguration Day. After he spoke bonds rallied and stocks fell. Evidently we are not the only ones listening intently to Gundlach’s views.

Another one of our favorite investing legends is Stanley Druckenmiller. He spoke this week at the Robin Hood Conference in NYC. Druckenmiller does Gundlach one better. He believes that the yield on the 10 year will rise to over 6% in the next year or two!! Druckenmiller is shorting the Euro and the Yen and he believes that if the 10 year rises above 3% then the stock market could see a 10% correction. Let’s face it. The stock market can face a 10% correction if someone sneezes in the Middle East.  A 10% correction is not something to be feared but anticipated. I think that the real takeaway is that at some point the yield on the 10 year becomes more enticing to investors than being in the stock market. The pendulum will swing and bonds will usually give you the correct signals. Keep an eye on the 10 year for hints as what stocks will do.

This Sunday’s referendum in Italy is the markets next boogeyman. Journalist and pundits are predicting the next great financial calamity if there is a “No” vote in Italy. Where have we heard this before? Italy has had 67 governments formed in the last 70 years. Why should 2017 be any different? We don’t mean to diminish the battle that is going on with bad loans at some of Italy’s biggest banks but somehow after seeing the predictions that Brexit would be bad for markets and Trump would be bad for markets we have a hard time believing the next great financial calamity follows the next populist regime change. The Italian Referendum should be another interesting vote. It might be time to become familiar with the name – Beppe Grillo.

Market is working off its collective over bought and oversold conditions. The 10 year closed Friday at 2.39% and should see resistance at the 2.5% level. Stocks have relieved some of their overbought condition but the Trump Rally is seeing some buyer’s remorse at 2200 on the S&P 500. Keep an eye on Italy this weekend.

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

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.

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.

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

 

 

Warren Buffett’s Favorite Metric

Warren Buffett’s favorite metric for the market over the years has been the Ratio of US Market Capitalization to United States GDP. Here is a copy of it below from Ned Davis Research. Ned Davis Research is one of the best independent research outfits in the business and I have followed their insights for over 25 years.

What I find fascinating about this chart is the high levels of valuation since the mid 1990’s. I believe that this time period should be considered the Golden Age of Central banking. This was the Era of Greenspan and the Greenspan Put. Alan Greenspan was the Chairman of the US Federal Reserve Bank from 1987-2006. It was Greenspan that realized the power of central banking. Central bankers in previous eras did not have the tools at their disposal to manage monetary policy as effectively as Greenspan. It was the removal of the Gold Standard by Richard Nixon which allowed central bankers in the US to pull forward growth in order to manage downturns more effectively. Note however that since 1995, valuations in the market have exceeded the average levels consistently with the exception of the 2008 crash. That leaves us with some very big questions. How long can central bankers keep pulling forward returns? How long will markets continue to give higher than normal valuations to markets based on central bank policy? Ned Davis Research

The one era most like our current one is that the late 1936 – early 1937 period. Current high levels of Price Earnings ratios, and, historically low 10 Year yields combine in a disturbing stew now as they did in 1937. Coming out of the Great Depression Federal Reserve officials saw prices in the stock market build to uncomfortable levels and with inflation on the horizon began to raise interest rates. The first tightening in August 1936 did not hurt stock prices or the economy, as is typical.

The tightening of interest rates was made worse by currency wars as European nations chose to move in the opposite direction of US monetary policy. The world began to demand US Dollars and gold. As inflation picked up to 5% the Federal Reserve raised rates further in March of 1937 and again in May 1937. This tighter monetary policy reduced liquidity and sent bond and stock prices much tumbling. Stocks would bottom a year later down 50% from prior levels.

Given the high level of valuations in the Golden Age of Central Banking how will assets perform if the Federal Reserve wants to exit the policies that brought forth those valuations? Central bankers may find that The Golden Age of Central Banking may give way to the Roach Motel of Central Banking. They can get in but they cannot get out.  It’s all about how markets react to the second and third rate hikes.

In our last blog post we mentioned the key levels for the market and now we are there. The bulls did not have much trouble surmounting the 1940 level but 2000 may prove more difficult.

The next level for the bulls is the 2000 number on the S&P 500 and then 2020. We have a confluence of moving averages and resistance zones to overcome here but the bulls have the bears on the run and shorts are covering as they feel the pain.  The risk at the moment is skewed to the downside as we have come very far very fast since the lows of 1812 in mid February. The market is extremely overbought and needs to rest. Let’s see if the bears can push back the bulls. Markets are looking for central bank intervention and if not from China this weekend then perhaps the ECB next week. Shorts are feeling the pain and the bulls may have their hearts set on 2100 on the S&P

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 below its 200 DMA we are inclined to believe that we are in a bear market and continue to hedge risk. Let’s see if the bulls can get above and stay above the 200 DMA.

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. Forced 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 week. Investors may be catching a falling knife there with more pain to come.

In our last blog post we asked you to keep an eye on gold. We feel that foreign investors could find solace here as the games of currency wars and negative interest rates heat up. That continues to be the case. Gold has been the star of 2016 and this week was no different. The yellow metal may be due for a rest but it might a short one. Negative interest rates in Europe are helping as are the concurrent currency wars between Japan, China, the US and Europe. Hold on tight and keep an eye on gold. Ray Dalio was at the University of Texas this week telling retail investors that they should consider holding 5% of their assets in gold. Look at Sprott Physical Gold Trust (PHYS) ETF and SPDR Gold Trust (GLD) ETF if you are determined to hold gold in your portfolio. PHYS has had better performance this year than GLD.

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.

Never Just One Cockroach

History suggests two immediate consequences from tightening: higher volatility and lower valuations, meaning earnings and ultimately the economy are left to drive prices. Psychologically, bulls and bears will get an answer to a question that has lingered over markets: how much of the Standard & Poor’s 500 Index’s 202 percent jump since March 2009 is sustainable without stimulus? – 12/16/15

http://www.bloomberg.com/news/articles/2015-12-16/pulling-life-support-from-a-bull-market-on-the-brink-of-history

As you probably know the Federal Reserve raised interest rates this week for the first time in over 7 years. The changes to that policy are bound to have some sort of negative repercussions exacerbated by an environment where all other of the large central banks are still in easing mode. We have spoken before about the effect of the US Dollar on Emerging Markets and commodities and those effects will only be worsened by the changes in Fed policy. We are not saying that Fed policy is wrong we are just looking out for the Piper to be paid.

 The buildup in government debt, he said, “tries to prop up the economy at the expense of the future.” Zero-interest-rate policy pushes consumption forward and changes the discounting mechanism, he said. Indeed, there no discount mechanism, he said, so you “fully value everything.”

“Once you’ve done all of those things you are quite a few yards into the tractor pull,” he said. “And that sled is getting heavier and heavier and heavier. That is why it is getting harder and harder to make money.”- Jeffrey Gundlach Doubleline Funds 12/8/15

 There is never just one cockroach. The biggest headline for us over the last two weeks is not the Federal Reserve policy change, as that was widely anticipated, but the redemption requests and subsequent suspension of those requests from the Third Avenue High Yield Fund. Third Avenue is a highly respected player in the institutional money game. This is not some fly by night Ponzi scheme. The fact is that Third Avenue got caught swimming naked when the tide went out in the high yield market. As you well know, the high yield market is dominated by energy companies and the descent of oil from its lofty perch has decimated that space. Understand that a redemption request is just investors looking to get money out of a fund and cut their losses. That is usually not a problem. However, when a fund suspends those requests they are saying that they need more time to come up with the cash. Selling too much, too quickly may upset the market for those assets and cause the fund to sell at fire sales prices. As for the broader market this can cause a cascading effect. If this fund sells at a huge discount then other may be forced to sell and we create a viscous spiral. So they put up the gates. By putting up the gates investors search elsewhere for liquidity asking others funds for cash and forcing them to sell. And around and around we go. This is what crises are made of.

The large spread between the top 10 stocks in the S&P 500 and the rest of the market is also flashing a warning signal. A bifurcation in the markets is a sign that the rally has gotten too constrained and is losing steam.

The S&P 500 has a big performance issue that should be a focus for investors: Too much of the index return is coming from too few of its stocks.

The 10 most valuable companies in the market are up roughly 14 percent as a group this year, versus a loss of close to 6 percent for the rest of the stock market.

That 20 percentage-point spread between the biggest stocks and the rest of the index is the widest since 1999, heading into the dot-com bust.

A widening of the spread between the market’s best performers and the rest of the market should be viewed as a cautionary sign. Jason Trennert Strategas Research Partners 12/9/2015

http://www.cnbc.com/2015/12/09/its-back-a-bad-sp-500-data-point-last-seen-at-dot-com-bust.html

We continue to see an upswing in volatility here in the 4^th Quarter of 2015. We believe that will continue in 2016.  While we are cognizant of low returns in this environment we have believed it prudent to have cash on the sidelines. We are now getting closer to putting some of that to work given lower asset prices in response to Federal Reserve policies. We expect 2016 to be a year full of volatility and opportunity. We wish you all a very Merry Christmas and a Joyous Holiday!

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.

Investors Spooky October

While October has traditionally been a spooky month for investors the only thing scaring investors this October was the huge gains in the stock market. 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.

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

While the S&P 500 has moved back into the trading range that it occupied in the first half of 2015 it that would indicate that, at the very least, the market is due for a breather. We believe that the current upside in the market is therefore limited and that a pullback is not only likely but healthy for continued market gains. We are concerned about the lag in Small Cap stocks and what that may indicate for the market in the near term. We saw an exciting rise in Large Cap indexes in October but their Small Cap brethren have not kept pace. Usually, that signals a weakness in the market as investors flock to the relative safety that Large Cap stocks provide rather than seek out the higher risk/reward paradigm of small cap growth. This anomaly could also indicate a near term change in direction of stocks.

The current general consensus is for the market to make further gains as the traditional Santa Claus rally appears into the end of the year. We believe that the October rally has brought forward much of those gains and further gains into the end of the year will be muted. We would expect the market to take a breather and settle into a trading range as we close out 2015. It is a little early to foresee what 2016 holds in store but given the volatility that we have since August of this year we believe that 2016 will continue in the same vein and be a volatile year. While higher volatility does not indicate a top for the market higher volatility does tend to appear in the last act of an aging bull market. We could be seeing a market that compares in time to the 1999-2000 market when the Federal Reserve was preparing to raise interest rates.  We believe that 2016’s returns will be +/- 20% for the year. Not very exact or comforting but it does allow us to plan. That plan would include more and larger tactical moves than we have made in the recent past.

“What you saw in the third quarter of this year could well have been a harbinger of things to come over the next year or two,” Bruce Karsh, CIO and cochairman of Oaktree Capital Group said October 29 after the company reported earnings. 

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.

Fickle Stock Markets and Daughter’s Driving

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

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

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

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

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

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

When there is no one left to sell…

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

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

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

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

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

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

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

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