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.

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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.

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It’s Just Math

So much to say and so little space. Let’s jump right in.

What Happened?

Investors are convinced that Interest rates have begun to move higher and may have broken their 30 year + downtrend. The US 10 year has gone from 2% to 2.85% in just 5 months. The 10 year is in every risk calculation. The risk free rate is a base from which just about every valuation springs from. Has the 30 year bond bull market ended? It seems more and more are in that camp.

It can’t be just Bonds. Can it?

No. The severity of the move was exacerbated by the short volatility trade (see our warnings Very Superstitious, Less In and Fall is In the Air) and market structure which we warned about My Name is Mario, Paradox and Caution Flags.

Short Volatility Trade

In the next sharp market move volatility will be the driver as investors scramble to cover their shorts wiping out many involved in that trade. Blog Post 10/21/2017 “Very Superstitious

Bonds, the Vol Trade and Risk Parity

We continue to fret about risk parity and volatility selling. When stocks go down we will look at bond prices. At some point they will both go down in tandem and selling will beget selling. If there is a meltdown, we believe that is where we will see it start. Blog PostLess In” 11/18/2017

Market Structure – Or Why the Market Fell So Fast

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

You may have pundits who say that it cannot be bond yields. They will say, “Four years ago the 10 year was at 3%. 3% 10-year yields didn’t stop the bull market then”.  Yes, but 3 years ago the S&P 500 was at 2000. It is now closer to 3000 with a high of 2872 put in a month ago. The S&P 500 at 2000 with a 3% ten year yield is a lot more palatable than when the S&P 500 is at 3000. Stocks are more expensive and have a lower dividend yield in 2018. Remember, stocks are valued in light of the risk free rate – the 10 year yield.

We are now in the late part of the short-term debt/business cycle when demand is increasing faster than the capacity to produce, so interest rates rise to put the breaks on and that hurts investment asset prices before it hurts the economy. -Ray Dalio Bridgewater Associates LinkedIn 2/8/18

The three legged stool of a higher stock market since the GFC has been stronger economic growth, low inflation and central bank stimulus. Those components of a stronger stock market may become a headwind in 2018. Currently, the Atlanta Fed is predicting 4% GDP in Q1 of 2018. That tells us that if growth gets much stronger central banks will have to take away stimulus at a more rapid pace. Inflation is rising with higher wages and central banks are already scheduled to take away stimulus in 2018. Don’t fall for the stronger economy = stronger stock market argument. A stronger economy and higher inflation will only lead to the Fed tightening faster. Trump’s policies may force the Fed to take away stimulus.

The combination of experimental central bank monetary policy and the Trump administration’s stated goals, if not enacted in concert, raise the risks that something is going to break. Those stated policy goals, while giving the Federal Reserve cover to raise rates, also make the Federal Reserve’s exit from their easy money polices of the last 8 years particularly tricky. To be frank their exit was never going to be easy. Blog Post Witches’ Brew 4/8/2017

Governments want inflation – just not too much inflation. Great investing minds such as Jeff Gundlach and Paul Tudor Jones are telling us that inflation is coming and commodities should play out well this late in the cycle. Central banks still have negative rates in parts of the world and in the US we have a President trying to stimulate the economy and having success. Right policies, wrong timing. Central banks are now behind the curve and markets may not like faster tightening. Another issue is the Fed Put. The Fed Put has given investors enormous confidence to buy ever rising stocks. Where will the Fed step in if markets get in trouble? We think that as inflation rises the Fed Put moves lower. The Fed cannot repeat the mistakes of the Weimar Republic and let inflation rage out of control. They will need to stop inflation and the acceptance of more volatility and a lower stock market may be the price.

The fundamentals have changed. Good news has become bad news. Any positive developments on the economy may be translated to a need for more tightening from the Fed. As Main Street benefits in higher wages Wall Street may suffer. Inflation will create the regime change from global economic recovery to global stimulus withdrawal. Governments want some inflation. Some inflation is good. From a government’s perspective deflation is always bad. That is why the Fed will support the market in a deflationary environment but not support it as quickly when it comes to too much inflation. Their support of the market is much, much slower to arrive in an inflationary environment especially when it sees a White House that is already stimulating the economy fiscally.

We have grown weary of hearing one pundit after another tell us that “The fundamentals have not changed; that the economy is strong and that stocks will go higher once this correction has run its course.” It is precisely because the fundamentals have not changed that stocks are weak, for the history of equities is to discount the future and the equity markets are looking beyond today’s economic fundamentals… which are, again, very strong… and are looking to the future when those fundamentals will eventually change for the worse. That is the job of the capital markets: to discount the future by looking into the future and not looking at the present. Dennis Gartman – The Gartman Letter

Bull market tops are a process and are usually not an event. We believe that we are at the beginning of that process. Fixed income is becoming more attractive as rates rise and central bankers will now attempt to step away from their support of assets. We do not think that they will have any luck but we think that the next 12-18 months in markets will be difficult with a strong increase in volatility.

This is what we had to say last month.

We believe it is prudent to be a bit more conservatively positioned this late in the cycle and expect lower returns in order to be prepared to profit from others panic and flawed market structure. Paradox 1/8/18

 

We were prepared for this selloff and continue to position our clients for success in this environment. We have been underweight equities and have shortened bond duration as far we can stand. We continue to expect volatility and market shocks while being prepared for the return of inflation and to profit from both.

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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.

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.

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.

The Risk to the Rally

The Risk to the Rally is the Rally itself. We came across a note from a research firm that we will not name. We highly respect the firm but the comment struck us like a thunderbolt. “Nothing can seemingly stop this market in 2018”. That is a very bold statement with 11 months to go in the year. A great start that has us running with the bulls but investors may be getting just a bit ahead of ourselves.

“With a 6.1 percent year to date gain and just three down days in the fifteen trading days of 2018, nothing can seemingly stop this market in 2018,” the firm’s analysts wrote Wednesday.

So far in 2018 we have rising bond yields, full employment, a Federal Reserve that is raising rates, trade friction, a falling US Dollar, tax reform and a runaway stock market. The punch line is that we might as well be talking about 1987. We wrote last year that the Trump Administration’s policies may give the FOMC the cover that they need to raise rates. The problem now is that Trump Administration policies could force the Fed to raise rates faster than they would like. A seemingly lower US Dollar policy, tax reform, trade wars and deregulation all could help foster that inflation the FOMC has been wishing for and force them to be more hawkish when it comes to monetary policy. At some point those rising yields will put pressure on risk assets.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. Mnuchin said recent declines in the value of the dollar against other currencies were “not a concern of ours at all.” – Steven Mnuchin US Treasury Secretary

From our good friends over at the Global Macro Monitor blog here is their thoughts on the latest developments out of Washington DC.

We have voiced our concern as we have noticed over the past few weeks the dollar weakening as interest rates are rising. A red flag.

Bad Timing 

The U.S. economy is humming at full capacity with inflation already on the cusp of moving higher. A weaker dollar is, effectively, a monetary easing and makes the Fed’s job that much harder at a time when financial conditions are incredibly loose.

The Administration also just announced the implementation of tariffs on solar panels and washing machines. LG Electronics has already announced they plan to raise prices on some of its models.  Retaliation by our trading partners seems likely.  Ergo inflationary pressures increase on the margin

https://macromon.wordpress.com/

The measured pace of the Federal Reserve is much like the measured pace of the Greenspan Fed in the mid 2000’s. The paradox then was that as the Fed kept raising rates at a measured pace the market kept roaring higher. Effectively, financial conditions got easier the more the Fed raised rates. That is the same paradox we have today. Financial conditions indicate easier conditions as the market heads higher with rising yields.

We feel that looser financial conditions are being exacerbated by the Fed’s frog in the pot. If the Fed continues to slowly boil the water asset prices will continue to trend higher, however, the downturn in markets, when it comes, will be worse. The Fed, at some point, should shock markets and raise rates 50 BP. Unfortunately, we do not feel that they will have the political will to hit markets with a 50 BP rate rise. That would certainly get markets attention. Otherwise, it may be up to inflation or possibly a trade war to get the market’s attention.

https://www.zerohedge.com/news/2018-01-24/us-financial-conditions-easiest-2000-despite-5-fed-rate-hikes

https://www.bis.org/publ/qtrpdf/r_qt1712a.htm

Howard Marks is out with his latest memo this week and it is well worth the read. He has a new book coming out in October that we are looking forward to reading on cycles. Here are some of the highlights of what he had to say on his Latest Thinking this week. Go on to read the entire memo. It is worth the time.

The bottom line of the above is that some people are excited about the fundamentals, and others are wary of asset prices.  Both positions have merit, but as is often the case, the hard part is figuring out which one to weight more heavily.

 Closer to the bullish end of the spectrum or the bearish end?  Or balancing the two equally?  My answer today, as readers know, is that I would favor the defensive or cautious part of the spectrum.  In my view, the macro uncertainties, high valuations and risky investor behavior rule out aggressiveness and render defensiveness more sensible.

For one thing, I’m convinced the easy money has been made…., isn’t it appropriate to take less risk in equities than one took six years ago?

Prospective returns are well below normal for virtually every asset class.  Thus I don’t see a reason to be aggressive.

At times when the economy does well, risk doesn’t rear its head, risk-takers prosper and the returns on low-risk alternatives are unattractive, investors tend to drop their prudence and conclude that high prices aren’t a problem in and of themselves.  This usually turns out to be a mistake, but it can take years. – Howard Marks

https://www.oaktreecapital.com/insights/howard-marks-memos

Now it seems that everywhere there is talk of melt up. We pointed to that possibility over a year ago. We tend to be early. Being early is a good thing. It allows for us to prepare. It is time to prepare. We are preparing for higher interest rates, higher than expected  inflation so that leads us to consider adding commodities and further shortening our duration in bonds while also cutting back on risk overall. The January Barometer tells us that with January up 7.5% in 2018 that should lead to a positive year. Great start but no time to rest. Keep in mind there may be some bumps along the way.

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/ .

pexels-photo-722664.jpeg

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.

2018 What’s Next?

At the end of the year we begin to formulate ideas about how the next year in investing will transpire. We build scenarios and that helps us invest accordingly. In late 2016 this is what we had to say in our blog about 2017.

Seemingly, every single investing professional that we read or talk has the same expectations for 2017. Experts see a January dip being bought and Wall Street’s best and brightest see 2017 returning a rather staid 5% on average according to Barron’s. We have a funny feeling that isn’t quite how it’s going to work out. When everyone agrees – something else will happen. 

There was no dip to be bought in January and, obviously, the market returned far more than 5%. Since December 2016 in the post Trump election world we have been harping on the idea that we could see a 1987 type of market. While that year brings nightmares to investors you have to remember that before the October crash the market was up 35% on the year. Well, the Dow Jones is now up 35% since Trump was elected while the S&P 500 is up just over 26%.

Our attention in 2018 will be dominated by the draining of liquidity by the world’s central banks. Available research estimates that the G4 balance sheets will peak in Q1 of 2018 and begin to decline. An inflection point will be reached in or around the summer of 2018 when liquidity injections by all four major central banks will end and central banks will begin to drain that liquidity. Since the dawn of the crisis we have felt that any draining of liquidity by central banks would cause markets to shudder. We expect no less in 2018 if central banks should go forward with their plans.

The Fed put strike is falling with rising rates even if markets don’t realize it. As our Head of Global Economics, Ethan Harris, has pointed out, sitting at the lower bound in rates put the Fed in risk-management mode, meaning they had to be ultrasensitive to the risk of making a policy mistake as they had no traditional ammunition to fight a potential downturn. But as the Fed gradually increases rates, and with markets seemingly unconcerned, they will inherently become less sensitive to risk. In other words, the Fed put strike is falling both because the Fed is rebuilding ammunition, and because it recognizes that markets can better stand on their own. Of course surprise inflation remains the real killer as it would effectively handcuff the Fed from providing a high strike put, and will require much higher stress before they can step in. – Bank of America

Investors are seemingly whistling past the graveyard. The market continues to move higher with the underlying belief that any market turbulence will be met by the Federal Reserve’s (The Fed Put) efforts to calm markets. Are they right? As Bank of America is saying investors may be overestimating the extent to which the Federal Reserve can or will seek to contain any market damage.

We still see the possible tax reform passage as a “sell the news” event especially in light of end of the year regulatory funding issues. We are beginning to see some stresses in the system due to that end of the year regulatory funding. Not a major problem but it could cause some ripples. Investors may be looking to push sales and any subsequent gains into 2018. That could cause more selling at the beginning of 2018. This could be a negative unintended consequence of the tax bill passage.

We hope that you will not take us to task for not posting yesterday. We took the day to spend it with our children in the snow. It doesn’t snow that often here in Atlanta, never mind 5 inches of snow, so we take our opportunities when we can.

The market is showing signs of slowing its ascent. It needs a breather although the Santa Claus Rally is just around the corner. We are watching key levels on the charts that the computers might be pointing to. We are also formulating our end of the year letter which will be out in several weeks and we hope to point to more of what we see happening in 2018.

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.

Want to Live Longer?

Andrew Scott is a Professor of Economics at the London Business School and is a co- author of The 100-Year Life: Living and Working in an Age of Longevity. I came across his work in an interview from the Council of Foreign Relations and I find his work helpful, not only in planning for client’s retirement but also in looking at the emotional side of retirement. We have had massive transformations in how we long we live our lives and in the quality of our lives since the dawn of the 20th century. Scott’s work shows that a 65 year old today is equivalent to being 51 in 1922! Something to accept going forward is that our lives will be longer and lived with a greater vitality and, in accepting that, working longer needs to be part of our retirement plan. Not necessarily in that same job some of you might dread going to everyday but working at something we love doing. Importantly, Scott’s research found that white collar workers that work longer – live longer. Something to consider.

65 is the equivalent to 51 in 1922, and today’s 78-year-old, in terms of mortality risk, is the equivalent of a 65-year-old. And you think about this longer life expectancy—you know, by some counts, children being born today can expect to live to high 90s, early 100s, if not more. It’s not clear that simply saving more will solve the problem, as we’ve been talking about here.

People never save enough anyway. People are fairly unresponsive to interest rates. So I think if we’re looking at how we finance longer lives, it’s going to have to be working longer.

And of course what is very striking with the data, too, is that effectively blue-collar workers, the earlier they retire the longer they live. White collar workers, the longer they work, the longer they live. I mean, it’s—old age has a very varied distribution across individuals, and some of that is strongly linked to income and particularly education. – Andrew Scott

https://www.cfr.org/event/retirement-challenges-individuals-global-comparison

Some pundits that stand out as perpetual bulls on the market are calling for a respite in 2018. We think that they might be right. The market has been on quite a ride this week and we used the rally this week to lighten up for some of our more aggressive clients. We still see the possible tax reform passage as a “sell the news” event especially in light of end of the year regulatory funding issues and a possible government shutdown dead ahead.

The S&P 500 is now up 13 months in a row and seems to have hit a speed bump. As the technology stocks hit their old highs from 2007 the computer algorithms hit the sell button and began to buy value stocks. Changes in investment positioning may be in store as value may begin to outperform growth. Growth has been the winner for perhaps a bit too long as returns try to revert back to the mean.  The yield curve here in the US is the flattest it has been since 2007 and we worry that it is about to invert and signal a recession. We warned two weeks ago that volatility would return and that it was only a matter of when. Well, it seems like this was the week. We expect more volatility to come as funding pressures increase with the turn of the calendar.

We have talked about the animal spirits being in control and now perhaps it is the computers turn. Keep an eye on key levels. We are watching 2666 on the S&P 500 very closely. The market bottomed at 666 in March of 2008. 4 times 666 is 2664. Close enough for government work. Programmers are humans after all and some numbers jump off the page. Call us crazy but we feel that it is an important hurdle and, make no mistake, the computers are in charge. We are still in it to win it but just a little less and a little less in.

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.

My Name is Mario and…

We have talked about the rise in central bank balance sheets and how those balance sheets may be THE most important metric when investing in this era. The European Central Bank (ECB) made an announcement this week and it seems that central bankers while promising to cut back and reduce balance sheets are already hedging their bets. The ECB, while slated to end their form of QE in December, announced that they will continue to use until September of 2018. But they are promising to cut back their monthly usage in half. Like an addict that says that they will quit just not right now. This form of monetary heroin is responsible for the rise in asset prices and it is causing distortions like European High Yield yielding less than the US 10 year. This is the height of lunacy. We are not happy being right. It is our job to make money so while central bankers print and buy assets we stay at the party. The bigger question is will central bankers ever stop printing?  While we see that the G-4 central bank balance sheets are slated to stop growing in 2018 we question the will of central banks to stop the monetary heroin.

We are stuck in our thesis on the concept of the “Fed Put” and how that is going to evolve and effect asset prices. One of the drivers of this relentless march higher is the idea to BTFD. Buy the Dip. Every dip in stock prices is bought because you don’t’ have to worry because if there is a real crisis the central banks will come in and back stop the market. So you find yourself asking, will prices ever go down? That alone has us nervous. If something cannot continue forever it won’t. The market will go down at some point. It always does and it is never different this time.

Tech stocks had a phenomenal week as we saw Amazon up 13% and Intel up 7% on Friday alone. It is starting to feel like a mania as the animal spirits have taken over. The broader market did show some technical signs of weakness. A warning shot across the bow perhaps? We still think that a tax plan passage is a sell the news event.

This is a one way market and investors need to recognize this and take steps to manage risk. Recalibrate. Market structure is responsible. 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.

The ten year Treasury broke through 2.4% and closed the week at 2.416%. We are looking for a new range between 2.4% and 2.6%. Above 2.6% and the warning lights will come on. The bulls are still firmly in control. 2600 on the S&P 500 is the next logical stop. Much as 666 loomed large in early 2009 the number 2666 now looms large for the S&P 500 and is less than 4% away from current levels. Wall Street and investors are a superstitious lot. The animal spirits are unpredictable and in control. Gotta be in it to win it but, maybe just a little less in.

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/ .

Diogenes and The Bond King

Jeffrey Gundlach from DoubleLine Funds gave another one of his webcasts this week. In a world of investing you have to know who is telling you their honest thoughts and who is just talking their book. We believe that Gundlach tells you his honest thoughts and his track record shows that he is well worth watching. The first thing that you need to know is that Gundlach is a bond fund manager who is not that high on the bond market right now. The “Bond King” doesn’t like bonds. How is that for honest? The Greek philosopher, Diogenes, would have never found what he was looking for on Wall Street, but then again, Gundlach is in LA.

Gundlach is constantly on the search for anomalies that may warn of an impending recession. In his “chart of the day” Gundlach presented a chart showing a ratio of the value of commodities to the S&P 500. The median value over the last 50 years stands at 4.1. That ratio is currently less than 1. That tells us that either commodities are very cheap or equities are expensive (or a combination of both). The last two times it got this low was just before the 1970’s Oil Crisis and during the Dot Com Bubble. Gundlach predicts that commodities will gain steam next year when the US 10 Year rate rises. Time to look at commodities.

One chart that Gundlach brought up was what we would term “The Chart of Next Year – 2018”. It shows the growth in the G4 Central Bank balance sheets since the beginning of the GFC until now and it overlays the rise in Global equity value. If you accept that the rise in equities was fueled by the rise in central bank balance sheets understand that the G4 balance sheet is projected to shrink beginning in 2018. Stalled growth in central bank balance sheets will equal stalled growth in equity prices and lower returns. A decline in central bank balance sheets will lead to a decline in equity prices around the globe.

QE has been highly correlated with risk assets (specifically the S&P 500) “levitating,” Gundlach said. That has been true since 2009 and on a global basis, he said. The actions by other central banks have lifted the prices of non-U.S. equity markets.

Gundlach said that when earnings are revised down, equity prices fall and vice versa. Except that wasn’t true when QE was going on. Now that central banks are tapering globally (“quantitative tightening”), it is a bad sign for equities, according to Gundlach.

“Maybe we will start getting into trouble in mid-2018, as QE goes away and the German 10-year yield goes up,” Gundlach said.

West Texas Crude is still below $50 a barrel but is challenging that critical level of resistance. The Saudi Arabian government is rumored to be looking at delaying its very important IPO of Saudi Aramaco.  Saudi Aramco is their state owned oil company and the biggest oil company in the world. It is valued in the Trillions of dollars!! Could it be because they are seeing higher oil prices on the horizon? $60 a barrel in crude would bring in substantially more money in the IPO than $50. It’s a big bet by a big and knowledgeable player.

Just to review. This week we experienced Hurricane IRMA, North Korea test fired a missile across Japan, terrorism in France and England while hard economic data continued to deteriorate in China and the US. So, logically, we should have new all time highs in the stock market and the best week of the year for the Dow Jones Industrials. By the way, if you needed any more evidence that the computers are in charge the S&P 500 closed Friday at exactly 2500. While we are on the subject of crazy Jeffrey Gundlach pointed out in his webcast that European junk bonds have the same yield as a U.S. Treasury basket (the Merrill Lynch U.S. Treasury Index). He said that spread is typically 700 basis points or more.

Gold was able to hold $1300 this week.  The ten year Treasury rocketed off its lows of 2.05% to close the week at 2.20% it what looks to be a failed breakdown. The S&P 500 broke through 2480 to close the week at 2500. That makes the next target on the S&P 500 2540. The caution signs are still there but the market is still firmly in an uptrend. The punch through 2480 on the S&P 500 could instigate the animal spirits and give the bulls room to run. Friday was a Quadruple Witching meaning that 4 sets of options expired on the same day. It happens four times a year. Things can change suddenly after expiration as all hands were more concerned with the options market than the stock market itself. Early next week is going to give us better clues as to if this breakout in the S&P will get legs. Gotta be in it to win it but maybe just a little less in. Keep an eye on the 10 year and commodities.

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.

Caution Flags

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

“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.”- Janet Yellen Jackson Hole 8/25/17

In Janet Yellen’s speech this week at Jackson Hole she brokers the subject of market structure and her anxieties surrounding the structural integrity of the market given additional stress.  Will current market structure provide the liquidity needed given a stressful event? We think that it will not and a temporary condition will be created consisting of a lack of liquidity will happen for a time. The pessimist sees what would be a very scary moment if market structure lets us down in the next stressful period. What we see on the horizon is a market structure that we think will fail and will create a big opportunity. Market structure. We see the risk as real and evidently we are not the only one.

Dow Theory is the long running thesis that if Dow Jones Industrials are hitting new highs then its brethren in the Dow Jones Transports should be hitting highs as well. The Industrials make the goods and the Transports ship the goods. So if the one is doing well shouldn’t the other? We are not the only one concerned. By way of Arthur Cashin, comes Jason Goepfert recent notes on the topic.

Jason Goepfert, the resident sage at SentimenTrader noted the recent wide divergence between the Dow Industrial and Dow Transports. He recalls that prior similar divergences have rarely been resolved in a bullish fashion. Here’s a bit of what he wrote: The Dow indexes are out of gear. The Dow Transportation Average continues to badly lag its brother index, the Dow Industrial Average. The Transports are not only below their 200-day average, they just dropped to a fresh multi-month low. Yet the Industrials are more than 5% above their own 200-day average, a divergence which has tended to resolve to the downside for both indexes, especially in the shorter-term.

While we have the caution flag up we are intrigued by how many analysts and investors are calling for a downturn. When everyone expects something to happen something else usually does. From Bloomberg this week comes notes from Morgan Stanley, HSBC and Citigroup that markets long term relationships are breaking down and signaling that a correction is in store.

Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop.

“Equities have become less correlated with FX, FX has become less correlated with rates, and everything has become less sensitive to oil,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote in a note published Tuesday.

https://www.bloomberg.com/news/articles/2017-08-22/wall-street-banks-warn-winter-is-coming-as-business-cycle-peaks

At the beginning of this week stocks were very oversold and due for a bounce. Equities were so oversold, in fact, that we did buy some equities for underinvested and new clients. The S&P is now approaching very important resistance levels at 2450 and again at 2475. 2475 is THE resistance level that the market has been struggling with since mid July. The market looks tired here and the seasonality is not in its favor with September and the October debt ceiling approaching. A failure at 2475 could give the bears confidence. The S&P 500 saw support at its 100 Day Moving Average (DMA) and the 2420-2400 area is support for now. The next support is the 200 DMA at 2350 which is down about 3.7% from here. If markets fell to that level that would be a 5.5% drop from the all time highs, certainly, not a major crisis. However, the bulls would need to hold the 2350 level or then the bears are in charge. We are still concerned that while the S&P 500 has held in there the Russell 2000 is struggling. That coupled with high valuations and a negative Dow Theory signal has us sending up caution flags.

 

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.