The Great Escape

It is a 10 year anniversary for us this week. This week marks 10 years since our move to Georgia. It also marks the 10th anniversary of the dawn of the financial crisis. Not a coincidence I assure you. Having traded through the Internet Bubble and watched Lucent Technologies, which was that bubbles’ “Darling” stock, trade from $79 to 79 cents we knew the real estate market would have also have to get as bad as it was good. And in 2006 -07 it was very good. We foresaw the real estate crisis and sold our house in New Jersey for an exorbitant price which according to Zillow it still has not climbed back to. As a side note, Lucent never got back to $79 either. We say this not to brag but as an investment lesson learned well. Trees do not grow to the sky. Know when to cut back on your risk.

Not much is being made of the 10th Anniversary of the Great Financial Crisis (GFC) but there has been a lot of consternation surrounding the Federal Reserve’s most recent decision and path going forward. If we have established that the growth in central bank balance sheets around the world has been responsible for the run up in asset prices it stands to reason that any shrinking of those balance sheets would diminish asset prices. Here is another timeless lesson of investing. Never fight the Fed. While the Fed has spent the last 10 years injecting liquidity into the system to pump up asset prices it is now talking about taking liquidity out – Quantitative Tightening (QT). Ironically, during our time on Wall Street the phrase QT was a questionable trade, an error that needed to be resolved and it usually cost you money. The question facing us now is the Federal Reserve making a questionable trade and will it cost you money?

The economy is growing, albeit slowing. That is due to the immense amount of debt on the United States balance sheet. This slow growth is now being met by a central bank that seeks to raise rates and shrink its own balance sheet. Now instead of a tailwind, the economy and markets are looking at a headwind. As we have written in prior posts, the Federal Reserve could have been acting since December with the impulse that more stimulative fiscal policy was going to come out of Washington, in the post election period. The new administration Trumpeted the advent of a new era with tax reform and deregulation at its forefront. The Fed sought to get ahead of the curve by applying tighter money policy. Well, Washington is at a standstill and has provided none of the above.

Is the Federal Reserve making the ultimate central banker mistake? Are they tightening into a slowdown? The bond market seems to think so. The yield curve is flattening which indicates that bond investors do not see inflation on the horizon and see subpar growth in the economy. Yet the stock market keeps chugging along. Who is right? Generally, we always go with the bond market.  We believe that the Fed is tightening due to financial conditions and not economic conditions. That is what the stock market is missing. As long as the market expects the Fed to stop tightening because of slowing economic conditions then the market will continue to rally and the Fed will continue raising rates. Someone is going to blink first.

We think that the animal spirits playbook is still alive. Markets have not broken down and still seem to be headed higher. Higher markets may force investors to chase it even higher.

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

Oil continues to get pounded as it is down 20% from March highs even though things in the Middle East heat up. Oil may try to find a bottom here as oil production will slow below $40 a barrel, at least here in the US. Biotech has had a great week as investors rotate there as the pressure from Washington on that sector seems to have ebbed. Equities are still in the middle of what we anticipate to be the new range on the S&P 500. For now we see support at 2400 on the S&P 500 with 2475 providing resistance. Interest rates may have seen their interim low for awhile.

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

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

The Sun Also Rises

How did you go bankrupt? Two ways. Gradually and then suddenly. – Ernest Hemingway The Sun Also Rises

We have been pointing towards a looming crisis in the municipal finance area. No, this is not a repeat from last week when we talked about the fiscal problems in the great state of Connecticut. It was Illinois’ turn this week to make headlines. The two big ratings agencies, Moody’s and S&P lowered their rating on Illinois to one step above junk as its budget impasse dragged onward. Illinois will likely reach junk status by July of this year. It is now the lowest rated US state ever.

Big banks are complaining that their profit’s are drying up and this is mostly due to Federal Reserve polices. The yield curve is flattening which is stymieing bank’s ability to make money on loans while volatility in markets has dried up pinching trading profits. JP Morgan, Bank of America and Morgan Stanley all warned on profits this week as trading profits are blamed. We expect the Federal Reserve to heed their calls. The yield curve problem may take longer to solve but we should expect the Fed to allow for more volatility in markets. JP Morgan warned on trading in May of 2014. The market continued to march higher another 9% into December of that year.

The head of one of the largest asset managers on the planet, BlackRock’s’ Larry Fink, warned the equity market is not appreciating the message from the Treasury yield curve and we have to agree. The bond market continues to rally with the US 10 Year yielding a paltry 2.15% at week’s end. It is a caution sign that both the bond and stock markets are rallying while the yield curve flattens. Investors may be chasing the stock market a bit as there seems to be some evidence of FOMO. Fear of Missing Out as the market hits new highs. The laggards from 2017 YTD rallied this week and that tells us that money managers are chasing. This plays right into our animal spirits theory and the 1987 scenario. History doesn’t repeat but human beings are susceptible to making the same mistakes over and over again.

Oil had another rough week as it is still below the critical $50 a barrel on West Texas Crude (WTI). New pension and retirement money entered the market as the calendar flipped to the month of June. Equities have broken out of the range that they had been trapped in for the last 3 months. The range of 2330-2400 on the S&P 500 was broken last week and the market extended its move to just below 2440. We expect this breakout to extend to 2475.  For now, volume is low and the trend is your friend.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

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

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

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

 

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