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.

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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.

Anyone Have a Match?

The debt ceiling is coming! The debt ceiling is coming! Not quite Paul Revere but the Treasury market is showing signs that investors are getting concerned about the debt ceiling being reached in mid October as the CBO has warned. If Republicans can’t get a bill through that they have been working on for seven years how will they get the debt ceiling passed through the most polarized congress in history? Months ago we were looking at sweeping changes with the Republicans controlling both houses. Now, instead of tax reform, we are looking at a government shutdown. For once, gridlock in DC may not be so good.

We have been postulating for years that the reason that the economy is not doing well is that interest rates are too low and that there was no threat that interest rates would go higher. Think about it. There has been no incentive to borrow and buy a car, a home or invest in plant and factory. We can “put it off until next year” because we aren’t sure about the economy and rates aren’t going anywhere. We came across this blog post from Epsilon Theory and Dr. Ben Hunt. It is not the common thinking but that is usually where the answer lies.

The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen. Why in the world would management take the risk — and it’s definitely a risk — of investing for real growth when they are so awash in easy money that they can beat their earnings guidance with a risk-free stock buyback?

(As the Fed slowly raises rates) It will force companies to take on more risk. It will force companies to invest more in plant and equipment and technology. It will force companies to pay up for the skilled workers they need.

In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory.

My view: as the tide of QE goes out, the tide of inflation comes in. And the more that the QE tide recedes, the more inflation comes in.

Dr. Ben Hunt Epsilon Theory 

I agree with Dr Hunt that at some point central bankers may be asking – Why is inflation accelerating as we raise rates? How come we cannot contain inflation? In talking to business leaders over the last several years we have not seen many talking up their industry as “hitting on all cylinders”. Last month we spent some time with a leader in the medical device field which he says is booming. Industry players are borrowing for plant and equipment for the first time in years. Combine some tax reform with higher rates and BINGO! That joint is jumping. Central bankers have been pouring gasoline on the pyre for years with no effect. Pushing on a string. Higher rates may be the match and with too much gasoline on the fire inflation may be the result.

Markets have been quiet. A little too quiet. We have read story after story about the volatility trade and how volatility has to spike higher to flaunt this overcrowded trade. We agree but this year has been very quiet. How quiet? This year has seen its largest drawdown of only 2.8% on the S&P 500. That is a far cry from the 14% average. According to LPL, the S&P 500 has not had a drawdown of 5% or more in a calendar year only 5 times in the last 60 years and it has not happened in 30 years. NASDAQ was up 11 straight days until Friday. According to LPL’s Ryan Detrick this has happened 21 times since 1980. The next month on average for the NASDAQ is up 2.6% with 16 of those 21 being positive months.

The tapering of the Fed’s balance sheet looks to be still on schedule to start in September. The debt ceiling is scheduled to be hit in mid October. Short interest is back down to levels last seen in the second quarter of 2007 at the market peak. Equities are at the top of their new range on the S&P 500. For now we see support at 2400 on the S&P 500 with 2475 providing resistance. If they break through resistance then we are off to a new range of 2475-2550. The path of least resistance is higher for now but September looms large. The animal spirits are still in charge as long as the flow of the Fed’s balance sheet is neutral to positive.

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

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

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

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

 

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