Yellen – More Punch Anyone?

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

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

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

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

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

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

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

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

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

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

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

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

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.

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.

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

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

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

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

The13th Beer

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

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

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

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

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

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

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 .

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

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

Ride the Wave

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

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

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




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

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

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

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

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

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

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

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 .

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

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

What’s Next in 2016?

Summary 1/11/2016

Arthur Cashin – Volatility is Back!

Echoes of 1937

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

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

I will gladly pay you Tuesday for a hamburger today.

– J . Wellington Wimpy


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

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

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

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

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

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


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

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

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

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

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

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

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

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

The similarities are staggering.

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

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

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

Former Dallas Fed Pres Fisher 1/5/2016 CNBC

 What Next?

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

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

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

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

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

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

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

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

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

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

We continue to see an upswing in volatility here in the 4th 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 .

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.

Elevator or the Stairs??

Small caps have been our roadmap as we continue to assess the risk/reward conundrum that investing in a central bank dominated world presents. Small caps led us to see the shortcomings in the market before its brief fall in mid October which allowed us to use some dry powder and positively influence our returns this quarter. While the selloff was brief and somewhat violent the aftermath has been anything but. A long slow grind higher has all those who missed the selloff regretting their reticence. This bull market has been built on low volatility interspersed with infrequent violent selloffs. The market has a way of taking the stairs up and the elevator down. Our vigilance to any signs of volatility is of paramount importance and will continue to portend downside moves.

Our antenna is raised to any talk of increased bands of volatility in markets, of letting markets run. In the Federal Open Market Committee (FOMC) October minutes there is one paragraph that stands out for us and that is its mention of volatility. When markets began to rally in mid October its rally can traced to a Federal Reserve official commenting that it would be possible to delay the end of its Quantitative Easing (QE) program. It is evident in the committee minutes that it does not want markets to get used to officials jawboning markets when they become volatile. The emphasis is ours in the following statement but it does appear that the committee is willing to expand the bands of volatility. Stairs up and elevator down.

…members considered the advantages and disadvantages of adding language to the statement to acknowledge recent developments in financial markets. On the one hand, including a reference would show that the Committee was monitoring financial developments while also providing an opportunity to note that financial conditions remained highly supportive of growth. On the other hand, including a reference risked the possibility of suggesting greater concern on the part of the Committee than was actually the case, perhaps leading to the misimpression that monetary policy was likely to respond to increases in volatility. In the end, the Committee decided not to include such a reference. 

Minutes of the Federal Open Market Committee October 28-29, 2014

Bill Gross of Janus is out with his latest missive and in it he complains of Central Banks trying to cure this debt crisis with more debt and the consequences of such. He is one of several high profile investors calling for low future investing returns and the need for investors to have cash on hand.

Markets are reaching the point of low return and diminishing liquidity. Investors may want to begin to take some chips off the table: raise asset quality, reduce duration, and prepare for at least a halt of asset appreciation engineered upon a false central bank premise of artificial yields, QE and the trickling down of faux wealth to the working class. If the nursery rhyme theme is apropos to the future, as well as the past, investors should remember that while “Jack and Jill went up the hill,” that “Jack fell down, broke his crown, and Jill came tumbling after.

Bill Gross Janus 12/04/2014

One of our favorite investment letters to read is Jeremy Grantham as he takes a quantitative approach to value investing. His study of bubbles in markets has led him and his team to conclude that bubble territory is 2250 on the S&P 500. Here are his comments from his latest letter.

Nevertheless, despite my nervousness I am still a believer that the Fed will engineer a fully-fledged bubble (S&P 500 over 2250) before a very serious decline.

My personal fond hope and expectation is still for a market that runs deep into bubble territory (which starts, as mentioned earlier, at 2250 on the S&P 500 on our data) before crashing as it always does. Hopefully by then, but depending on what the rest of the world’s equities do, our holdings of global equities will be down to 20% or less. Usually the bubble excitement – which seems inevitably to be led by U.S. markets – starts about now, entering the sweet spot of the Presidential Cycle’s year three, but occasionally, as you have probably discovered the hard way already, history can be a snare and not a help.

Investors have reason to be excited. From a seasonal perspective this period of time from November 2014 to March of 2015 would represent, historically, the best period of returns. Market players may have a hard time resisting a rise in stock prices as the stars are aligned for further gains in this cycle if history and seasonality is any guide. It could however lead to a buying panic as equity valuations become further stretched and investor’s party like its 1999.

For the last few years the time to take profits has been when volatility shows up. When volatility calms down it is time to ride markets slow grind higher. Keep both hands on the wheel. When volatility rises take cover. When the storm passes you can advance. Volatility is the key. Higher volatility equals lower stocks.

Watch the Russell 2000 for clues to equity prices. Lower oil. Is it a supply issue or a demand issue? We think it both. It could lead to more geopolitical issues.

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 .

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.