Trapdoor

The bears won last week as any and all moves by the bulls were rebuffed. The bounces that are coming are of the bear market variety. They are large bounces on light volume as buy interest wanes. The gaps continue to remain unfilled at 2850 and 2700. The bear case is being validated. The 200 Day Moving Average (DMA) is what the entire street will be watching this week. The 200 DMA is a widely used gauge for investors as it is used as a barometer as to whether we are in a bear market or a bull market. We closed the week practically sitting on it. We have not been below the 200 DMA in almost two years since June of 2016. When we violated the 200 DMA in September of 2015 the market struggled for 10 months. We have been calling for the market to struggle for 9-18 months since we hit 2666 on the S&P 500 in December of 2017. We are now 5 months into that struggle. I can hear the question. Why not then just get out of the market? The market can do three things. Go Up, Go Down, or Go Sideways. By being invested you make money in two of those three scenarios. We don’t know that the market is going to go down. We have made some sales at these elevated valuations and with those proceeds we are prepared to makes purchases at lower prices.

If the 200 DMA is violated by a close this week we could see trapdoor selling. By that I mean that bids will be pulled and those who were once buyers become sellers.  Trump made noise again last week on the tariff issue but markets sensed something different in his tone. He tweeted that he would accept a stock market drop because it was up so much already and that trade tariffs are in the best interest of American long term. He might get some push back on that thought, especially, from the bulls.

April, which is historically the best month for the Dow, is off to a very bad start. New money for the month did not help tip the scales in favor of the bulls. The bulls do not have a lot of conviction and if the 200 DMA is violated momentum funds will become sellers further driving the market lower. We expected the market to test 2550 and we did see 2555. Close enough for government work. We now expect the 200 DMA to be tested and for Wall Street to fail that test. We did not see the market bounce into the 2700-2750 area and that gives more power to the bears. The stock market is primed and ready for a drop.

A short one today as we tee up our quarterly letter for next week. I think we will have plenty to talk about.

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.

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Monday’s Blueprint for Markets

Here is our Blueprint for Monday and beyond. Since the election of Donald Trump we have been building an investing scenario that looked much like 1987. We were calling for a 1987 style melt up and then, a smack down.

A 30% run from the lows before Election Day, much like 1987, …would put us squarely in bubble territory as the S&P 500 would approach the 2750 area. A subsequent 30% retreat would bring us back to the 2000 area. (The S&P 500 was at 2360 as we wrote.) Witches’ Brew Blackthorn Quarterly Letter April 2017

We may have missed the top by 100 points on the S&P 500. Last month we backed off of the 1987 style melt down part of this scenario in light of everyone jumping on the 1987 bandwagon. We have begun to expect a more drawn out solution but you must be prepared for either in this environment.

This is what we had to say in our blog post Warning Shot Across the Bow published 2/4/18.

Our new scenario calls for a more drawn out selloff. First, we may see a drawdown in the magnitude of 5-15% followed by a retracement back to the old highs. From there (You Are Now Here) we should see a selloff of a larger magnitude leading to a bear market over the next 18-24 months. It’s not voodoo. Valuations show that historically we will see limited upside from these levels. Markets are high. Rates are rising. The yield curve is flattening. Markets tend to struggle in the second year of a Presidency as midterm elections approach. It’s not rocket science. It’s the study of psychology and history. We have seen the warning shot across the bow.  Buckle up. It’s going to be a bumpy ride. Watch the central bank balance sheets. If they stop tightening all bets are off.

As far back as October of 2017 we were warning about the 2666 level on the S&P 500 and a struggling market for 18-24 months.

We felt that the market would struggle for 18-24 months when it hit 2666 on the S&P 500. The market has spent time at each multiple of the 666 low in the S&P. 2664 is 4x the 666 level. You must remember we are dealing with algorithms written by humans. Levels like 666 and 2x, 3x and 4x are just levels in a computer program. Be careful of computers. They only do what they are told. As computer use has created a wondrous cycle of upward movement so we can have the vicious spiral downwards.

Market structure could exacerbate may any selloff. We have warned about market structure in the past and here is where you can do further reading from our blog posts – My Name is MarioParadox and Caution Flags.

The market is flawed in its design as its automated structure puts the momentum players, the market makers and algorithms in control. While it is pleasurable to see it go up every day it will be much quicker and painful when the market goes down in a one way fashion. For every action there is an equal and opposite reaction. Blog Post “My Name is Mario” 10/28/2017

We mentioned on Twitter on Thursday morning that gaps at 2850 and 2700 would lead technicians to project a measured move lower to 2550. That was 4% lower as we wrote. We realized that a move of that magnitude would take the S&P down to test the lows from February’s vol quake. What we didn’t realize was how quickly we would get to that number. For next week the old school playbook is for a rough Monday and a chance for the bulls to turn things around Tuesday afternoon. We have a feeling that Wall Street didn’t study for this test. Market is very oversold and due for a bounce. How it reacts to the prior low (2550) will tell us a lot.

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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 .

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

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

Where Are We? – Emotional Capital City

Where are we? Markets are about cycles. We see them repeat over time. The question now is where are we in the cycle? One important reason why we need to be aware of cycles is because investing is an emotional roller coaster.  If we jump out of the market too soon we risk under performance and client angst. If we are too late clients may feel over invested and lack the courage to buy when others are selling. It is then that we run the risk of permanent capital loss. Our job as financial advisors is really about contingency planning, trying to anticipate what happens next and how to respond. An underappreciated part of investment management is how we, as advisors, react to our client’s emotional response. Our ability to respond to market cycles is directly influenced by where our clients are emotionally – their emotional capital.

We have spent a good deal of time lately talking to clients about emotional capital. When cycles reach a more mature stage it is prudent to sell some winners and build a cash (and emotional) cushion with which to buy future bargains. That way when market losses come you are keenly aware that you prepared for this moment and this money was set aside to buy assets at bargain prices. If you are holding too much in the way of assets when they begin to fall you will be tempted to start selling. It is then that you will be managing your money from an emotional point of view. We all know that losses hurt far more than gains feel good. Much as Joseph stored the grain in Egypt during the 7 years of plenty it is time to store some cash to prepare emotionally for when the lean times arrive. Leaving some gains on the table will make you a better investor over the long haul.

Now let Pharaoh look for a man discerning and wise, and set him over the land of Egypt. 34“Let Pharaoh take action to appoint overseers in charge of the land, and let him exact a fifth of the produce of the land of Egypt in the seven years of abundance. 35“Then let them gather all the food of these good years that are coming, and store up the grain for food in the cities under Pharaoh’s authority, and let them guard it. 36“Let the food become as a reserve for the land for the seven years of famine which will occur in the land of Egypt, so that the land will not perish during the famine.” -Genesis 41:34

We caution that we are not seeing anything imminent. We just know that trees don’t grow to the sky and bull markets end. We know that we are in the midst of one of the longest bull markets on record influenced by historical central bank largesse. We don’t know when but we are due for leaner years. We need to store some cash and build emotional capital. The people in the industry whose opinions we respect are advocating caution. Hopefully, it will only be a minor disruption but it is imperative that one is not “all in” when it arrives and we are emotionally prepared to purchase bargains. A recession is the big worry and that still seems some time away. 

The market is still struggling to supplant 2800 on the S&P 500. Bond yields are struggling with rising above 3% on the 10 year. Gold cannot seem to break out and hold above $1350.  The yield curve is flattening. The key takeaway here is that the pressure is building. We are at a crossroads. Bonds. Commodities and equities. We are all waiting.

The bears pushed back this week but we give a slight edge here to the bulls. Stocks are slightly oversold and bonds slightly overbought. The big option expiration came and went without incident. Next week, hopefully, will tell us more but we could just see the tension build. The bulls still need to get over the 2850 gap to really convince us but if they do things will progress quickly. Be on your toes.

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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 .

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 Ides of March

“Beware the Ides of March.” As we know from Plutarch, a Greek biographer, a seer had prophesied to Julius Caesar that harm would come to him by the Ides of March. He would, in fact, be assassinated on that day. Wall Street is a superstitious lot but it’s the bears that may feel they got assassinated last week. Some of the feedback that we received on our blog last week was that we were a touch bleak. We don’t feel that it is our job to talk about sunshine and roses. Our job is to be the cynic. Our job is to find the risk and avoid it or profit from it. We are not bleak on the market. We are just looking to manage risk and get the best risk return ratio for our clients. We are still heavily invested in stocks for clients but just underweight them as we feel that the risk reward here is turning against investors. In what is probably the best investing book ever written Benjamin Graham, of whom Warren Buffett is a disciple, outlines how to allocate your investment portfolio.

We can urge that in general the investor should not have more than one half in equities unless he has strong confidence in the soundness of his stock position and is sure that he could view a market decline of the 1969-70 type with equanimity. It is hard for us to see how strong confidence can be justified at the levels existing in early 1972. Thus, we would counsel against a greater than 50% apportionment to common stocks at this time. -Benjamin Graham The Intelligent Investor 

We wholeheartedly agree with Graham as to strategy but we also think that Graham would agree with us on the market’s current position and how to allocate in 2018. After seeing a massive run in the Dow Jones from 1942 -66 markets were struggling in 1969-70 period. The move lower from 1968-70 totaled a 35% loss in equities. That is the kind of loss Graham is talking about. Graham’s lack of confidence in 1972 was well founded as a massive bear market would take place from 1972-74. 

Markets tend to go higher over time and the majority of annual returns in stocks are positive. We don’t need to tell you that stocks are a very good investment over the long haul. Our job is to look at risk/return ratios and know when to back off. You wouldn’t bet on Secretariat to win if a $5 bet would return $1. The metrics on stock valuations are historically elevated right now and history tells us that equity returns from here could be subpar. There is nothing wrong with rebalancing, taking profits and taking down risk. We are not out of the market just underweight stocks. 50% in and 50% out. We can find a reason to be happy whatever Monday brings. The key to what Graham is saying is can you weather the storm? If you are overweight and you get a discount in prices you either cannot buy because you are already all in or will not buy because you lack the psychological and emotional will. You should never be all out and never all in. That way, when Mr. Market offers you a ridiculous price on a stock that you have always wanted to buy you are financially and emotionally ready to take advantage. Not gloom and doom. Just proper risk management.

The Ides of March were known in ancient Rome as a time to settle debts. It looks like the bulls settled one with the bears a week early. Last week we said that the line on the bull/bear game was a push. We thought that with the market a touch oversold the bulls had a slight advantage but that neither the bulls nor the bears really had the upper hand. Well, the bulls made it clear they are not ready to go away yet and shrugged off potential trade wars and another high profile resignation from the White House. The bulls had an outstanding week and let the bears know who is really in charge. The bulls now have the gap at 2850 on the S&P 500 clearly in their sights.

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 .

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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.

Back to the Future

It has been our central operating thesis since the Great Financial Crisis that low interest rates+ low volatility+ larger central bank balance sheets would = higher asset prices. We are now entering an environment where we are seeing higher interest rates+ higher volatility+ smaller central bank balance sheets. We surmise that will = lower asset prices. It’s just math.

The big news this week was probably Trump’s trade policies and tariffs on steel. On that subject we do not believe that those tariffs will see the light of day. He will lose when he goes to the WTO and will be forced to retract them but, then again, we think that his threatened imposition of tariffs is probably only a negotiation tactic. We had several discussions this week on tariffs with people we respect. They made several interesting points about trade and steel and tariffs. My contention is that none of that matters. Wall Street and investors see tariffs and they think trade war. They think trade war then they think about the Great Depression and Smoot Hawley with a shooting war to follow. When it comes to trade wars investors will shoot first and ask questions later. A trade war = lower asset prices.

This week we saw the new Fed Chair go in front of Congress and act hawkish on inflation. Markets reacted negatively. The very next day he seemed to walk back his earlier comments. This is precisely why, as investors, that we need to prepare for inflation. No one wants to fight it. It is not politically acceptable until it is too late. No Fed chair will have the political will to fight inflation until it is raging and it begins to hurt Main Street. The biggest beneficiaries of inflation are the largest debt holders. Who are the largest debt holders? Governments. They need to inflate away their debt. They want inflation because it allows the very existence of bigger government. The political will to fight inflation will not be there until it hurts and hurts Main Street badly.

CONFIDENCE ON INFLATION GETTING STRONGER” – “Hawkish” Fed Chair Powell

NO STRONG EVIDENCE OF DECISIVE MOVE UP IN WAGES, MORE LABOR MARKET GAINS CAN OCCUR WITHOUT CAUSING INFLATION” – “Dovish “ Powell

By far, the most interesting part of the week for us was an interview from Goldman Sachs of Paul Tudor Jones, a legendary hedge fund manager who called the 1987 crash. He has run a Global Macro hedge fund for over 30 years investing in stocks, currencies and commodities. Check out the whole interview if you can. Here are some of the highlights (emphasis ours.)

Interview with Paul Tudor Jones

Allison Nathan: Is the market underestimating commodity-related inflation today? 

Paul Tudor Jones: Absolutely. The S&P GSCI index is up more than 65% from its trough two years ago. In fact, relative to financial assets, the GSCI is at one of its lowest points in history. That has historically been resolved by commodities putting on a stunner of a show, stoking inflation. I wouldn’t be surprised if that happened again.

 Allison Nathan: Does all of this just boil down to the Fed being behind the curve?

Paul Tudor Jones: … The mood is euphoricBut it is unsustainable and comes with costs such as bubbles in stocks and credit. Navigating these bubbles will be one of the most difficult jobs any Fed chair has ever faced.

 Allison Nathan: In this context, what do you want to own?

Paul Tudor Jones:  I want to own commodities, hard assets, and cash. When would I want to buy stocks? When the deficit is 2%, not 5%, and when real short-term rates are 100bp, not negative. With rates so low, you can’t trust asset prices today.

 Allison Nathan: You are well-known for calling Black Monday. Is the recent surge in volatility behind us?

Paul Tudor Jones: In my view, higher volatility is inevitable. Volatility collapsed after the crisis because of central bank manipulation. That game’s over. With inflation pressures now building, we will look back on this low-volatility period as a five standard- deviation event that won’t be repeated.

If you are a regular reader you know that one of our biggest concerns is rising bond yields. By way of our friend, Arthur Cashin, comes some insight on those rising bond yields. Barry Habib is quoted from time to time in Arthur’s Daily Letter and his track record is nothing short of amazing.

 We are going to see 3.04% on the 10-year within the next couple of weeks. That will be the moment of truth. The level of 3.04% matches the top of the 30-year downtrend in yields, as well as the 0% retracement from the highs 4 years ago. In other words…it’s a big deal if this is convincingly broken to the upside, and strongly suggests that the 10-year will hit 3.80% before summer.

Interestingly, Paul Tudor Jones spoke of rising bond yields in his interview. His thought is that the 10 year goes to 3.75% by year end and that was a conservative target. We thought that the S&P 500 would make a run to the old highs but it seems that talk of trade wars has aborted that attempt. The struggle between the bulls and bears is a push right now. Either could take over. Markets are a bit oversold here which gives the edge to the bulls but the failure to trade to old highs and trade war talk tilts things in favor of the bears. So much to say in such a small space. We are looking forward to our quarterly letter where we will get more in depth in some of these issues.

From the Back to 1987 Department:

Gluskin Sheff’s David Rosenberg summed it all up nicely“Hmmm. Let’s see. Tariffs. Sharp bond selloff. Weak dollar policy. Massive twin deficits. New Fed Chairman. Cyclical inflationary pressures. Overvalued stock markets. Heightened volatility. Sounds eerily familiar (from someone who started his career on October 19th, 1987!).”

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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 .

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.

Warren Buffett’s Latest Wisdom

One of my favorite days of the year is when the annual report of Berkshire Hathaway comes out. It is always on a weekend and we spend a good amount of time pouring over it for wisdom from the Oracle of Omaha – Warren Buffett. Here are our highlights from his latest missive.

On the Current Deal Making Environment:

 Buffett noted in his annual address that prices for assets are challenging. In his never-ending quest to deploy more money and buy companies he described that finding a deal at “a sensible purchase price” has become a challenge”.

Investment Lesson On Buying Stocks:

 As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates. (emphasis mine)

Investment Lesson On Markets:

Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.

Given historically stretched valuations and Mr. Buffett’s comments validating the difficulty finding sensible acquisitions it demonstrates the difficulty in purchasing stocks at a sensible multiple of earnings given prevailing interest rates and interest rates trend higher. We do not mind looking unimaginative or even foolish at this period in time in being underweight assets and overweight cash.

Much has been made about new Fed Chair Powell and the hand dealt to him by the former chair. You could not pay me to take Powell’s job. He is doomed to fail – by design. Powell is left to try and reset monetary policy after almost a decade of emergency policy. His job is to tighten monetary policy and give the Fed room to respond to the next crisis with a smaller balance sheet and higher rates from which to cut. He will tighten until something breaks and break it will. How else will he know if he has tightened enough? It is his job to “fail” and he will be the fall guy for Congress and Trump.

Last week we spoke of zombie companies and pointed to HNA Group out of China. We were close to the mark as it was ANBANG a $315 Billion insurer that was bailed out by the Chinese government this week. Markets barely blinked. Rates are rising and taking the tide out with them. Who will be caught swimming naked next and when will markets care?

We are still pushing towards the old high in the S&P 500. Remember, that is the key test for the market. We keep hearing pundits suggest that we must test the lows put in during the VIX Crash. Not so. The bulls were running so hot since the election it is the old HIGHS and not the lows that hold the key to future market direction. 

The 10 year Treasury has moved to resistance at the 3% level. As the 10 year tries to push through 3% equities continue to sell off. As the 10 year backs off of its assault on 3% equities continue to run higher. We think that the 10 year should at least struggle to get through 3% and that should allow equities time to retest the old highs. The gap at 2850 should draw the bulls like a moth to flame. Gaps are technical indicators because it shows massive change in sentiment and the psychological underpinnings of the market. If the market should struggle and fail at 2850 on the S&P 500 (and see the 10 year rise above  3%) then the bears may be in charge.

lighthouse

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.

Trump Stepping on The Gas

As Warren Buffett famously said, “When the tide goes out you find out who has been swimming naked”. That tide may be rising interest rates. The tide has only begun to recede and yet it appears we may have found some to be swimming naked. In recent weeks we have seen unexpected announcements from the likes of Met Life and GE in regards to accounting irregularities and large conglomerates in China and the Netherlands with liquidity issues. HNA Group which owns Hilton Hotels is desperately searching for liquidity. The tide hasn’t even gone out yet. This could be the tip of the iceberg as zombie companies which have been left alive due to central bank zero interest rates may now fight to stay afloat. The rising tide of interest rates should bring us more instances of who has been swimming naked.

Coming off one of the worst weeks in years for equities we now have one of the best weeks in years. Don’t be lulled into complacency. This was to be expected as investors have now reversed half of the sell off after retesting the lows at the key 200 day moving average. We do not think that the all clear can be given yet. The selloff was violent from extremely elevated levels and that should give us caution. The true test, as we have been warning, is the retest of the old highs. The old highs were hit with such fervor that we do not think that the amplitude will be the same when we get there again. The swift and violent move off of the extreme highs has brought doubt into the equation for the first time in awhile. Let’s see if equities can pass this exam.

It appears that the expected outcomes by market participants may have changed the moment the tax bill was passed. Fiscal stimulus this late in the business cycle with a performing economy could force the central bank to tighten quicker than it had planned. That only increases the level of difficulty of the high wire act that the central bank is already attempting. The odds of a central bank policy mistake are rising and that contributed to the selloff along with rising inflation and the prospect of higher interest rates. Another contributing factor of the sell off was that Wall Street can smell weakness. Much had been made about the overzealousness of the volatility selling crowd. Those sellers were ripe for a lesson and Wall Street gave it to them. Wall Street, when sensing weakness, will press the case against the weak. Much like culling the slow and weak from a herd Wall Street feeds on the same. We have no doubt that the case was pressed against vol sellers until they capitulated. That gave rise to further de leveraging which spurred the computers into an all out rout. The key question here is, has the tide turned? We will see soon enough when the highs on the S&P 500 are tested once again.

Point here being that the uber-ambiguous “something has changed in the market” meme that’s been going-around is based-upon the underlying change in perception with regard to a bond market that is waking from its slumber due to a new-found Central Bank willingness to normalize policy on account of actual signs of “growth” and “inflation”—ESPECIALLY after being “put over the top” by US fiscal stimulus.  The above observations are simply the manifestations of this mentality-shift in the market….qualitative observation into quantitative phenomenon.- From Charlie Mcelligott, head of Nomura’s Cross-Asset Strategy

We have been writing that the Trump policies would give the FOMC cover to raise interest rates but those same policies may be too much of a good thing. Fiscal stimulus, tax reform, deregulation and infrastructure spending may force the Fed to raise rates faster than they would like. As the Fed is hitting the brakes Trump is stepping on the gas.

We continue to hold short duration bonds coupled with a slight underweight in equities. However, we did cautiously add to equities during the selloff. We continue to add to new positions that prepare for a further rise in inflation. We believe that we are in the late stage of the business cycle where commodities tend to prosper. Current central bank positioning combined with fiscal stimulus could lead to a quicker than expected rise in inflation. We are positioning for a surprise to the upside.

pexels-photo-722664.jpeg

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.

Warning Shot Across the Bow

Bitcoin’s rise and fall has been fascinating to watch and its technology may, in time, be of great significance but for now but the most important takeaway for us may be the signal that the rise and fall of bitcoin has now seemingly produced. The rise of bitcoin leads us to the inescapable conclusion that its very existence and subsequent popularity is due to excess liquidity in the financial system. After real estate, stocks, bonds, art, rare automobiles have all reached excessive valuations it was time for a new asset to arise for money to flow. We may look back in time to see that the rise of bitcoin was the last gasp of the “Everything Bubble”, a time when every asset on the planet was at extreme valuations due to central bank policy. We believe the fall of bitcoin coincides with the threat to withdraw liquidity from the system by central banks led by the United States. Like air, bubbles require excess liquidity to form. The market is a discounting mechanism and is, at the dawn of 2018, discounting 6 months forward the withdrawal of liquidity. The warning shot has been sent across the bow for investors. Of course, central bankers can always just stop draining liquidity and even add more but the tide seems to be going out for now. Watch for who has been swimming naked.

I think there are two bubbles. We have a stock market bubble and we have a bond market bubble…I think [at] the end of the day the bond market bubble will eventually be the critical issue…In fact I was very much surprised that in the State of the Union message yesterday all those new initiatives were not funded and I think we’re getting to the point now where the breakout is going to be on the inflation upside. The only question is when…We are working our way towards stagflation. – Alan Greenspan former FOMC Chair Bloomberg TV

Jim Paulsen from Leuthold Group joined Jeff Gundlach and Alan Greenspan calling for commodities to outperform in 2018. That’s a pretty elite group. Commodities tend to outperform at the late stage of the cycle. Here is what Paulsen told CNBC’s Squawk Box.

“Challenges are mounting here for stocks,” Paulsen told “Squawk Box.”“And for bonds, I think.”

“The values have been high. They still are. You’re losing the element of surprise. You know, these economic and earnings reports are fabulous, but we know they’re fabulous,” he added. “It just has never felt this bullish.”

At some point, the economic and earnings numbers won’t have the same impact on the market they had previously, Paulsen argued. He sees commodities outperforming stocks and bonds this year.

A 15% selloff from the highs would only bring us back to market levels of August 2017! A 20% selloff brings us back to January 2017! Not the end of civilization. In fact, a healthy retrenchment of recent gains. We felt that the market would struggle for 18-24 months when it hit 2666 on the S&P 500. The market has spent time at each multiple of the 666 low in the S&P. 2664 is 4x the 666 level. You must remember we are dealing with algorithms written by humans. Levels like 666 and 2x, 3x and 4x are just levels in a computer program. Be careful of computers. They only do what they are told. As computer use has created a wondrous cycle of upward movement so we can have the vicious spiral downwards.

We have talked of a 1987 style market for over a year now complete with melt up. Now it seems all the rage to compare our current market to 1987.  In fact the two years are eerily similar. We build scenarios and invest accordingly. Now that everyone is on board with the 1987 style melt down we are getting off the train. Our new scenario calls for a more drawn out selloff. First, we may see a drawdown in the magnitude of 5-15% followed by a retracement back to the old highs. From there we should see a selloff of a larger magnitude leading to a bear market over the next 18-24 months. It’s not voodoo. Valuations show that historically we will see limited upside from these levels. Markets are high. Rates are rising. The yield curve is flattening. Markets tend to struggle in the second year of a Presidency as midterm elections approach. It’s not rocket science. It’s the study of psychology and history. We have seen the warning shot across the bow.  Buckle up. It’s going to be a bumpy ride. Watch the central bank balance sheets. If they stop tightening all bets are off.

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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/ .

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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.

Fear of Missing Out

Courtesy of Cashin’s Comments this week comes an interesting insight about the bond market from a stock market maven who has had a hot hand. Jim Paulsen sent our friend Arthur Cashin an email in which he explains history’s treatment of stocks when bond yields move quickly.

Since 1980, when the 10-year bond yield was more than one standard deviation below its trend, the S&P 500 average annualized gain in the ensuing year was a robust 14.25%! When the 10-year yield was within either one standard deviation above or below trend, the stock market’s average annualized gain in the subsequent year was still a healthy almost 10%. However, when the bond yield was more than one standard deviation above its trend, the stock, market in the following year only provided a paltry 2.71% average annualized gains.

Moreover, whenever yields were higher than one standard deviation above trend, the stock market declined in the ensuing year 43% of the time compared to only about 19% the rest of the time! Within the last month, the 10-year Treasury bond yield has risen beyond one standard deviation above trend (as of Jim’s writing the 10 year was at 2.44%. It ended the week at 2.66%!). Consequently, despite ongoing strength in equity prices, the recent rise in yields may already be starting to pressure the stock market.

Let’s combine that thought about the bond market with current equity valuations. Courtesy of FPA Capital is their note that when the levels in the CAPE Ratio rise above 26, returns from equities decrease. Returns in the past 100 years from current CAPE Ratio levels average NEGATIVE 7% over the next 3 year period.

 

  • When S&P 500 CAPE was below 10x, 3-yr returns of 39%; between 10x and 14x, returns of 34%; between 14x and 18x, returns of 13%; between 18x and 22x, returns of 20%; between 22x and 26x, returns of 22%; between 26-30x, returns of negative 1%; greater than 30x, returns of negative 7% (31x today!!!)

 

From a technical perspective we are awestruck by the current level of Relative Strength in the S&P 500. The RSI is at its highest level ever. Ever! The word Unsustainable comes to mind.

Investors seem to be in panic buy mode in a Fear Of Missing Out (FOMO). Money has flowed into mutual fund and stock ETF’s at the highest pace ever over the last four weeks. $58 billion in fresh money hit markets in the last month. Last week was the 7th highest week ever according to Bank of America. That money came into the market after the market was off to one of its fastest yearly starts on record. We are setting a lot of records lately. That has red flags rising left and right. It’s not to say that the market roar won’t continue but at this pace the market will be up 166% for the 2018 if things continue. What cannot continue – won’t. Trees don’t grow to the sky.

We would remind you that in our blog last week we noted Bond King Jeffrey Gundlach’s line in the sand for equities. In his latest conference call Gundlach stated that the 2.63% level on the 10 year is going to be a very important level and at which stocks may begin to suffer. The 10 year closed the week at 2.663%.

The combination of higher rates, the end of QE and tax reform may push the market and economy into overheating. Late stages of bull markets can have very sharp and quick moves to the upside. It is starting to feel more like 1998-99. That’s the key. Are we in 1998 or 1999? It makes a big difference for our returns. Watch for price acceleration.

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/ .

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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.

BitCoin

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

The most important aspect of investing to master is the psychology of investing. If one is not aware of one’s emotions surrounding money and gains and losses one can never master the art of investing. The parabolic price rise and constant chatter surrounding the rise of bitcoin has all of the hallmarks of a mania. The bitcoin mania has pundits and media types all aflutter. That emotion works its way into mainstream investing.

We are seeing very large money flows into the market as investors see the big returns of bitcoin and want some for themselves. That reminds us of another Warren Buffett quote. “What the wise man does in the beginning the fool does in the end.” According to CNBC, ETF inflows had their second biggest week in history. We believe that the parabolic rise in the price of bitcoin and the mania surrounding it has driven investors to an extreme in bullishness. That has led to the S&P 500 becoming overbought (According to its RSI) to a level not seen since 1995. Investors are plowing money into stocks excited by bitcoin’s parabolic rise. The FOMO Fear of Missing Out has investors, perhaps, getting in a little over their heads.

For months we have mentioned the idea that the market could stall at the 2666 level on the S&P 500. We made mention of the fact that 2666 is just about 4 times the bottom print in March of 2009 of 666 on the S&P 500. Also, our thesis included that this number, and its biblical significance, would play a part in Wall Street traders psychology and in Quantitative Funds computer programs. For those of you who thought we were nuts, by way of Zero Hedge, comes a chart which shows that the market has struggled with multiples of 666 since March of 2009. The S&P 500 when hitting 2x and 3x the low of 666 has spent the next 18-24 months in a consolidation pattern. Signposts like this along the way are good spots for investors to take a respite and reflect on how far we have come and whether the trend should continue. 2018 may be a Year of Reflection.

4x 666 S&P 500

 

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/ .

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.